The Dirt Insurance Scam

Lenders require you to do a lot of things to protect them. They require title insurance - even if you're refinancing property you already purchased title insurance for (another scam), sometimes they require you to get mortgage insurance (yet another scam), they sometimes require you to escrow money for taxes and insurance, to make sure those are paid. If somehow you don't have property insurance, they will invoke "force placed" insurance, where they buy very expensive insurance and put a lien on your property to pay for it. Some of this is understandable - a mortgage holder has a big investment in your property and doesn't want it to be uninsured in case of fire. Much of it, though, is wasteful overkill. One of the most common, in these days of 90 to 100 percent loans, is what my insurance agent and I refer to as insuring dirt.

Land is something that is hard to damage; if you have a fire that burns your house to the ground, it still won't harm the ground to where you couldn't use it to build another house. Typically, the land is considered about 20% of the value of a property. This can vary, of course, and 15-25% is a range accepted pretty much without question. If you have a unique property (a high-rise apartment building, or a lot of acreage) then maybe the land is worth much less or more than this range, but we'll deal with the typical 20%. Insurance agents and mortgage companies know this very well. It's why your insurance agent (if they're honest) will tell you not to insure the dirt (land) against property damage. If you have a duplex property worth $150,000, then if 20% of that value is in the land, your building is worth about $120,000. There's little need for you to have more than $120,000 in property insurance. Even if it burns to the ground you've still got $30,000 of land that hasn't lost its value.

The problem has been coming from 90-100% loans, where the mortgage company is insisting that the property insurance amount be for the full amount of the loan. In many states, including my own, this isn't legal. There are laws against insuring dirt, so to speak (or thin air). I would imagine the main intent of the laws was to prevent overvaluing buildings with insurance, then burning them to collect, but it also should keep people from wasting money on insurance they simply don't need. However, mortgage companies by-and-large have gotten away with this. I'm sure, in the hot go-go real estate markets of the recent past, they felt like this would be workable since the property values were likely to rise. In a short time they could see all their loan value as insurable in just the value of the structures on the property. That didn't make it right, though, and now it really works against the borrower in the flat-to-down real estate markets in most of the country. Yet, the mortgage companies still insist you over-insure your properties on the 90-100% loans. There are three problems with this:

1) It may not be legal, and you may have a hard time finding an insurance agent who will do it.

2) It costs you wasted money insuring dirt.

3) It can cost you too much in property taxes.

The reason for number 3 is that your property tax assessor also knows that your land is worth something like 20% of your total property value. When you challenge the property value (and you should from time to time - that number they assign your property for taxing is just a number, not a hard fact), the first thing the tax assessor will look at is how much insurance you carry. If, from the above example, you are carrying $150,000 of insurance on a property where the land is worth about 20%, the assessor will say you've provided your own proof that the property is worth more like $187,500 and will want to tax you for that much. They will figure the $150,000 insurance is on the building only and add in some value for the land. You can appeal further, but you'd have to get current appraisals and other proofs to fight it. The tax assessor won't care that the mortgage company forced you to get too much insurance.

So, what to do? In spite of the fact that insuring dirt isn't right (and sometimes isn't legal), you're going to have little luck getting the mortgage companies to change their ways. Maybe eventually state attorney generals will take them on to stop this waste and abuse, but you aren't going to have much luck on your own. If you have to have the loan, then you have to have the loan, and you'll pay for a little more insurance, and you'll find an insurance agent who will look the other way on the dirt insurance (there are plenty who will - to a point). But, you're not stuck. Your mortgage note will have some requirement that you have adequate property insurance. This would be typical: "Borrower shall keep the improvements now existing or hereafter erected on the Property insured against loss by fire, and any other hazards for which the lender requires insurance. This insurance shall be maintained in the amounts and for the periods that the Lender requires."

While it sounds rather iron-clad, no contract can force you to do something illegal, and I doubt many courts allowing the mortgage holder to force you to insure beyond their interest. A court would apply standards of reasonableness to this apparently unlimited requirement. In short, no one can force the mortgage company to give you a loan (so you play along if you want it), but in the long run the mortgage company can't force you to carry illegal insurance. Laws overide what is in a contract. You can sign a contract selling yourself into slavery, but slavery is illegal so the contract would be void, for example. So, after you've settled in to your new loan, some time before you go down to discuss with the property tax assessor what your property is worth, call your insurance agent and reduce your coverage to a correct amount (it wouldn't hurt to consult with a Realtor or appraisor to get their ballpark idea of a number). Within a few days you'll receive a new "dec sheet" or declarations page, showing the coverage from the insurance company. That is what you take to show the tax assessor. Doing this also lowers your insurance costs to what they should be.

What happens after that? Maybe nothing. The mortgage company may not react at all. However, often you might get a letter saying you need more coverage. You just write one back explaining that you've discussed this with your insurance agent, and they felt you had the property over-insured. In fact (in states where it applies), you have discovered that carrying that much insurance isn't legal (your insurance agent will know, but most state laws can be searched on the internet now). Chances are, that will be the last you'll hear from the mortgage company. They know they shouldn't require more insurance than is necessary, and fighting with you, possibly in court about it wouldn't be worth it. I suppose it's possible a mortgage company could try to play hardball and try additional force place insurance, leaving you with the choice of whether to take them to court, but I've not seen it happen. If they do try to be hard about it, try negotiating - maybe there is a number a little higher than yours and a little lower than theirs that you can agree on.

To my knowledge, no one has tried to measure how much money is wasted on extra insurance and taxes by mortgage companies requiring too much insurance, but it has to be a very large number - and it is all money that could have been used to pay on the mortgage itself; no small matter in these days of high foreclosure rates. It's always a good idea, though, to see if you are paying for insurance you don't need.