Home equity loans, HELOCs and insurance requirements

A home equity loan or HELOC is a second lien on your house, and the second lender will almost always require you to keep homeowners insurance in force and to name it on the policy as an additional mortgagee. You do not need a separate policy: one homeowners policy can list both lenders. What changes is who gets paid after a claim, how much coverage the combined debt calls for, and what happens if the second lender decides your coverage lapsed.

What the second lender will ask for

The requirement comes from the loan agreement and the deed of trust or mortgage that secures it, the same sources as for a first mortgage (what mortgage lenders require from your homeowners policy). Expect these items:

• Proof of current coverage at application or closing: a declarations page or evidence of insurance showing the property address, policy period and dwelling limit.
• The lender named as mortgagee or additional interest, with the loan number, so it receives notice of cancellation and shares in claim payments.
• Coverage adequate to protect the combined debt. There is no single federal formula for a second lien. Lenders commonly look at the total of the first mortgage and the equity line against the dwelling limit, but each sets its own rule. Ask for the requirement in writing.
• Flood insurance if the home is in a special flood hazard area. The federal mandatory purchase rule covers any loan secured by improved real estate, so it reaches home equity loans and lines as well as purchase mortgages. See NFIP flood insurance explained.

Fannie Mae's guide itself treats second mortgages as a lighter case: the insurer-rating requirement does not apply to a second mortgage unless Fannie Mae also owns the first (Selling Guide B7-3-01). That is Fannie Mae's rule for loans it buys; a bank holding a HELOC in its own portfolio sets its own standards.

How claim payments work with two lenders

The standard homeowners form pays Coverage A and B losses to "the mortgagee and you, as interests appear," and if more than one mortgagee is named, "the order of payment will be the same as the order of precedence of the mortgages" (ISO HO 00 03 05 11, Section I Condition L, as hosted by the Maine Bureau of Insurance). In practice, the first lender is paid first and generally controls the claim check. See the mortgagee clause explained.

Say your dwelling is a total loss insured for $300,000, with $220,000 owed on the first mortgage and $60,000 on a HELOC (hypothetical numbers). Both lenders have a claim on the proceeds. The first lender's interest comes ahead; the second lender's balance follows; whatever is left is yours. If you want to rebuild, the lenders may allow the proceeds to fund construction, but each has to agree, and the second lender, knowing it sits behind the first, may be slower to sign off. That is a reason to tell both lenders as soon as there is a loss and to read why your mortgage company is on the claim check.

The practical lesson is that a HELOC makes underinsurance more costly for you. The higher your combined debt, the less of any shortfall you can absorb. Check that your dwelling limit would pay the first mortgage, the HELOC and a rebuild together; the How much homeowners insurance do I need? and How much dwelling coverage do I need? help.

Escrow and billing

Most home equity loans and HELOCs do not escrow for insurance. The first mortgage servicer usually pays the homeowners premium from its escrow account, so the second lender relies on proof from you or on the first lender's payments. If you pay your premium directly, send the second lender every renewal declarations page; it will ask. Escrow rules for first mortgages are in how escrow pays your homeowners insurance.

If the second lender thinks coverage lapsed

Here the picture differs. The Regulation X force-placed insurance rule, 12 CFR 1024.37, requires a 45-day written notice and a reminder before a servicer can charge you. But Regulation X defines "mortgage loan" for its servicing subpart as excluding "open-end lines of credit (home equity plans)" (12 CFR 1024.31). So the federal notice sequence applies to a closed-end home equity loan, but a HELOC servicer is not bound by those specific steps. State law and the credit agreement still apply. Many lenders send warning letters anyway, but do not count on 45 days.

Whatever the product, the fix is the same:

1. Keep the lender on the declarations page and confirm it after each renewal.
2. Answer any insurance verification letter immediately. Send the declarations page, not just a policy number.
3. Change the mortgagee wording when the loan is sold or transferred.
4. If a lender buys coverage, replace it fast and ask in writing for cancellation and a refund of overlapping premium. force-placed (lender-placed) insurance explained explains how that works for closed-end loans.

Before you open a line

Opening a HELOC is a good moment to review the policy, because the lender will look at it and because the debt makes a shortfall more expensive. Pull your declarations page and check four things: the dwelling limit against a current rebuild estimate, the deductible (a high percentage wind or hurricane deductible is easier to absorb when you are not also repaying a line), whether the mortgagee list is current, and whether any endorsement such as extended replacement cost is worth adding. Tell your agent what you are doing, because some lenders send their verification request straight to the agent, who can reply the same day. If you plan to draw on the line for a renovation, also tell the insurer: a major remodel changes the rebuilding cost, and the dwelling limit should rise with it. See your annual homeowners insurance review.

When the loan ends

When you pay off the HELOC or loan, ask the lender for a lien release and ask your insurer to remove it as mortgagee, as you would after a first mortgage (do you need home insurance after the mortgage is paid off?). A line of credit that is paid down to zero but not closed may still be a lien and may still require coverage, so confirm the account is closed and the lien released, not just empty. Reverse mortgages have their own insurance terms; see reverse mortgages and homeowners insurance: what you must keep in force.

Key takeaways

• A home equity lender will require homeowners insurance and will ask to be named as mortgagee on your existing policy; you do not need a second policy.
• Under the standard form, claim payments go to mortgagees in order of lien priority, with the first mortgage ahead of the HELOC.
• Federal flood insurance rules apply to home equity loans and lines secured by a home in a flood hazard area.
• Regulation X's force-placed notice sequence excludes open-end HELOCs; keep proof of coverage current with the lender anyway.
• Borrowing against the house raises the stakes of being underinsured, so recheck your dwelling limit.