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Reducing Risk
How To Choose The Right Insurance For Your Log Home
Kevin J. Daum
This article was originally published in the April 2005
edition of Log Homes Illustrated magazine.
Insurance for the home remains one of those great mysteries
of life. Most of us have it. We pay a log for it. But we never
really use it unless something bad happens to us. So here
is the chance to learn a little more about insurance.
First, let’s remove a common myth. It is not difficult
to insure log homes. I have financed many log homes in my
career, and I have yet to come across a client who had trouble
getting insurance because it was a log home. Log homes are
no more susceptible to fire or flood damage than any other
home, so most insurance companies are perfectly willing to
provide insurance for them.
Since most of you are looking to build a log home, I will
start by explaining the insurance requirement for a construction
project. These requirements are the same for a log home, timber-fram
home, panelized home or stick-built home.
If you are building your home all with cash from you own
pocket, insurance is simply a wise choice on your part for
protecting your investment. If you are borrowing money to
build, however, the lender will require specific insurance,
and the lender will demand to be named as co-insured. I have
seen many construction loans held up for insurance so call
your insurance agent early to get your policies lined up.
Here is a guide to the discussions with your agent.
Liability Insurance. This policy protects
you and your contractor in case someone gets hurt on your
property. It also protects you if someone working on your
property causes someone to get hurt on your project. Either
you or your contractor can carry this policy. If the contractor
carries the policy, it needs to meet the following criteria
to satisfy most lenders:
- It must be in the form of a comprehensive general policy
for $1,000,000 or the loan amount, whichever is greater,
or be a policy including broad-form liability endorsement.
- The contractor must be named as the insured, with you
and the lender named as additional insured.
In some states, it can be difficult and expensive for a contractor
to get this liability policy if he or she doesn’t already
have one. You may want to carry this policy yourself to ease
the process and save money since the contractor will likely
pass on these costs to you anyway. If you are an owner-builder,
the lenders will require you to carry the policy yourself
in any case. If you are carrying the policy, your agent will
issue the policy with a couple of changes from the requirements
above. First, you and the lender would be the only names on
the policy. The contractor would not be named. Second, the
coverage amounts change to $500,000 for each occurrence or
the loan amount, whichever is greater. This amount covers
both property and personal injury.
Workers’ Compensation. Workers’
comp, as it’s usually called, covers the cost of medical
bills and lost work time if an employee gets hurt while working
on your construction project. Usually your contractor carries
this policy for her or his employees. It’s a good idea
to request a copy of this policy since the lender will want
to see it. Often the contractor does not have her or his own
employees but hires subs and labor as independent contractors.
If you are acting as an owner-builder, you won’t likely
have any employees either. The subs will carry their own worker’s
comp, and you should check to make sure the coverage is current.
You can satisfy the lender’s needs by signing a waiver
so the lender won’t be held liable for any workers comp
violations. If you are using a contractor, this person will
have to sign the waiver as well.
Course of Construction. Every lender requires
a course of construction policy to protect against fire or
damage to the house while it is being built. Imagine if your
plumber drops her torch and starts a fire that burns the place
down to the ground. This policy will replace the structure
to its original state before it burned down. The cost of this
policy varies with the size and scope of the project. It can
run anywhere from $1,000 to $4,000. Not all insurance companies
will write this type of policy, so you need to start shopping
around well before you intend to break ground.
Here are the basic criteria that most lenders require:
- The amount of coverage must be equal to the estimated
replacement value of the improvements to be built, or the
loan amount, whichever is lower. Guaranteed replacement
is generally acceptable as opposed to a specific dollar
amount.
- Borrower is named insured, and the lender is named as
the “mortgage and the certificate holder.”
- The maturity date on the insurance is at least one day
beyond the end of the construction-loan term.
Homeowner’s Policy. Once your house
is complete you will need a homeowner’s policy to satisfy
your permanent lender and to protect yourself. The cost of
a policy varies, based upon the coverage you choose and the
replacement value cost of your home. As a quick rule of thumb,
you can figure a rough annual cost is your home value times
0.2 percent.
A typical homeowner’s policy is sold as a package providing
coverage in four basic areas:
- Hazard protection for the house structure. With the exception
of earthquakes and floods, which require additional policies,
this policy will cover fire, vandalism and most other disasters,
such as a car crashing into your home, falling trees or
airplanes dropping out of the sky. It will not cover normal
wear and tear or maintenance. This coverage should include
other structures on the property, like the garage and outbuildings,
although the coverage for these may be minimal. The lender
will require the loan amount to be covered, but you can
choose to insure for guaranteed replacement cost instead
since the house may cost less to build than your existing
loan amount. There is no need to insure the value of your
land.
- Living expenses in case of disaster. If your house burns
down or is wiped out in a hurricane, you will need a place
to live until your home is rebuilt. Never fear. This policy
will cover your living expenses including hotel bills and
meals up to 20 percent of your hazard coverage on the house.
You can pay to increase the coverage amount on this part
of the policy if four-star hotels are your idea of roughing
it.
- Hazard and theft protection for your personal belongings.
If your personal items are destroyed in a fire or other
disaster, they will be replaced. You are also covered for
replacement if your items are stolen. Generally, you are
covered up to 50 percent of the house amount. So if your
replacement cost is $200,000, then your contents can be
replaced up to $100,000. Additional binders can be purchased
for really expensive items, like your Beanie Babies collection.
It’s advisable to conduct an inventory listing all
your items and their value, in case you ever have a problem.
Many people do this with a video camera since it is easy
and the item can be seen. Just remember to keep the tape
or DVD someplace other than your home. A safe deposit is
best.
- Liability protection against lawsuits and judgments. Sadly,
in this day and age, there are two kinds of people. Those
that have been in a lawsuit and those who will be. As long
as our law schools keep cranking out lawyers, there will
be no shortage of sharks out there looking to make a buck
at the expense of your insurance company. Luckily, your
homeowner’s policy is there to help you when those
papers are served at your door. Your insurance company will
pick up the tab for a lawyer to defend you, as well as any
judgment if you lose – up to the policy limit of course.
Most people get coverage up to $300,000 but since judgments
are getting bigger these days, many opt for additional Umbrella
Policy, which can cover another $1 million in liability
for a few hundred dollars a year.
All of the insurance coverage we have talked about comes
with one little catch. It’s called a deductible. The
deductible is the amount of money the insurance company will
deduct from the amount of loss you are claiming. This means
you have to cover the deductible out of your own pocket. For
example, if you have a claim for $300,000 and your deductible
is 20 percent, you will get a check for $240,000 and have
to fix the property with the amount or make up the difference
yourself. You have a choice on how much deductible you want,
but the lower the deductible, the higher the price of the
policy. This is where you figure out your gambling tolerance.
If you reduce your deductible by $20,000 for a cost of $1,000
per year, and you go for 20 years with no claim, you lost
$20,000.
Mortgage Insurance. There are two types
of mortgage insurance, neither of which is beneficial to consumers
today. I have included them since I am asked about them so
often. The first is required when you purchase a home with
less than a 20 percent down payment. Today lenders offer piggyback
loans where they lend you a first and second mortgage in combination
up to 100 percent of the value of the house. This has all
but eliminated the need and cost for private mortgage insurance,
commonly referred to as M.I. or P.M.I.
The second type of mortgage insurance is usually offered
by your lender to pay off your mortgage in the case of your
death. This insurance is a rip off and should be avoided.
The premiums on these policies are exorbitant. You can get
a standard life insurance policy for much less money, and
the payoff will not decrease as a mortgage balance would.
As a rule, I don’t buy any insurance from anyone other
than an agent whom I know and trust.
The insurance industry today is heavily regulated. Most insurance
agents are informative honest people. The commissions are
relatively small, so it is important to them to keep your
ongoing business to make any money. Most will guide you through
the claim process in a helpful, attentive manner. Experienced
agents know tricks for getting the most out of the system.
There is no right or wrong with making all the decisions about
insurance. Beyond what the lenders require, there are only
decisions to make based upon your tolerance for risk. My advice
is to find a good insurance agent through friends and family.
Question everything so you understand the choices and go with
what helps you sleep best at night.
Kevin Daum is the Founder and CEO of Stratford Financial
Services, a Real Estate finance and education company, founded
in 1989. Stratford specializes in Purchase loans, Refinance
loans and Custom Home Construction finance and has successfully
financed thousands of clients. He is the author of "Building
Your Own Home for Dummies" (Wiley), as well as "What
the Banks Won’t Tell You." Mr. Daum was an Underwriter
for Plaza Savings and Loan and Key Bank of New York. He is
an INC 500 CEO and has been listed as one the 40 Most Influential
People Under 40 in the San Francisco Bay Area. He is the Global
Chair for the Edison Innovation Program with the Young Entrepreneurs'
Organization (YEO) and is a founding Board member of the Bay
Area Chapter of YEO.
Mr. Daum is a frequent contributor to numerous business
publications on the subjects of Real Estate and Small Business
leadership and speaks regularly on both subjects. He can be
contacted at kevin@stratfordfinancial.com.
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