Homeowner's Insurance for Condo Owners

October 2009

Fannie Mae has just announced a new rule that is important to anyone who owns a condominium, townhome, or a unit in a Planned Unit Development (PUD). In the case of a single family detached residence, your basic insurance policy covers everything, but that’s not true in the case of a condos and similar properties.  

There are three classes of assets in any home. The first is the exterior structural components, i.e. the walls and roof. Homeowners Associations (HOAs) cover this part of the property with their master insurance policy. Generally all state laws require an association to have only a “bare walls” policy. More on what this means later.

The second class of assets includes all of your personal property including furniture, art, books, clothing, and other personal possessions. You probably already have this kind of policy.

The third class does not generally occur for people. This class of asset includes all the interior items that are still attached to the home. This includes plumbing fixtures, cabinets, interior doors, kitchen appliances, furnace, light fixtures, wall coverings, carpet or wood or stone flooring, and everything in the bathrooms.  

It is possible that assets in this third class might have slipped through the cracks as you were considering coverage. You might have thought that the Association’s policy included coverage for these items, and, indeed, some associations do, but many more do not. Some personal property policies also include some coverage, but it might be minimal.

In the event of a total loss of your home due to fire, the Association’s policy would re-build the structure but leave you with “bare walls,” as in an empty shell. If you had that minimal coverage on your personal insurance policy, it would scarcely pay for rebuilding the interior of your home the way it is now, the way you like it.

Fannie Mae and Freddie Mac have finally realized this gap in coverage and have moved to close it. In typical government fashion, this rule seems to have been made without consulting either lenders or the insurance industry. Let me see, how can I say this nicely? Oh, I can’t – it is stupid. Why?

The new requirement is that the borrower must provide what is known as an HO-6 policy, which includes “walls in” coverage. That’s okay, but here’s the stupid part. Fannie and Freddie require coverage equal to 20 percent of the appraised value of the home. It should have been written to include 20 percent of the value of the improvements. As written, you have to pay to insure 20 percent of the value of the land that is included in the total appraised value.

In a desirable area, the land is likely to be 50 percent of the total value of your home, so 20 percent of the appraised value is over twice what 20 percent of the value of just the improvements is. This means you have to pay for double the actual coverage you need. An owner of a $1,000,000 unit would be required to pay for $200,000 of coverage which might be far in excess of what the actual replacement cost is likely to be.  

Finally, this requirement conflicts with state laws that forbid lenders from requiring more insurance than is actually indicated as the realistic insurable value. In this case, state law says that owners can’t be forced to buy “excess” coverage, but a lender isn’t going to fund your loan without it. Talk about a Catch-22!

Currently this applies only to new loans, but as sure as the sky is blue, you can be sure that Fannie and Freddie are going to tell loan servicers to start making sure that each property for loans they service has this same coverage.

I hope that Fannie and Freddie will change their policy to something more realistic, so stay tuned. In the meantime, if you live in a condo or PUD, take this opportunity to get your master policy and sit down with your insurance agent to make sure your personal property assures that you are adequately insured.