Over-insured by a mile
Marsha Miller had just landed an attractive rate to refinance her small house in Torrance and was close to wrapping up the deal when the mortgage company made a perplexing demand. A representative told her she would need much more insurance on the 1,200-square-foot home. Rebuilding the place after a fire or some other disaster, the company warned, could cost as much as $490,000, the home’s appraised value.
The message was clear: Fail to buy more homeowners insurance, lose the $293,000 loan.
Closing was days away. Miller was confused. Her insurance company had assured her that the almost $160,000 of coverage she had on the house was enough to rebuild the place from the ground up. The mortgage company, expressing concern about its investment, now insisted she carry -- at the very least -- enough insurance to cover her loan balance in the event the house was destroyed.
“It made no sense to me,” Miller said. “My insurance agent was saying, ‘You don’t need this much insurance. Rebuilding your home would never cost that much.’ ”
The insurance agent was right. The demand the mortgage company was making is actually illegal in California. But, according to consumer calls received by insurers and state regulators, Miller is among an increasing number of homeowners who buy more insurance than they need at the instruction of their mortgage companies.
Consumers are urged by experts to resist such demands. Yet those who don’t know any better are buying the policies and throwing away hundreds -- even thousands -- of dollars.
Homeowners insurance is based on what it will cost to rebuild a house. In Los Angeles County, that usually amounts to $120 to $200 per square foot, depending on the quality of the home. But in Southern California’s ever-inflating real estate market, a three-bedroom house that would cost $200,000 to rebuild could easily sell for three times that amount.
The value of the land accounts for the difference. The house might burn down, but the land will still be there. Insurance typically pays to rebuild the house and covers some contents.
During the California real estate boom of the late 1980s, lenders were making the same demand: As the prices of homes spiraled upward and buyers were taking on more debt than ever before to get into the market, anxious lenders seeking to do everything they could to protect their investments required clients to be insured up to the purchase price.
Then, state law did not prohibit it. Homeowners forced to purchase such policies saw their premiums jacked up hundreds of dollars for what amounted to phantom coverage. The trend raised concern in Sacramento, where legislators in 1988 passed a law that forbids lenders from requiring clients to buy insurance beyond what it would cost to rebuild a house.
“The state passed the law to say, ‘Timeout. You can’t require homeowners to pay for insurance that has zero value whatsoever,’ ” said Los Angeles real estate attorney Ira Waldman.
The law still stands. But as lenders become bigger, make loans out of state and outsource their California work to employees all over the country, the law often gets overlooked. In most states, where the housing prices are much lower, it is perfectly normal -- and legal -- to require loan applicants to insure for the entire purchase price. That’s because the purchase price can be less than the cost of rebuilding -- something unimaginable in most of Southern California.
Lending officers get confused and make unreasonable demands on their California customers.
“It definitely happens,” said Mark Prather, owner of a Cerritos mortgage company that works with more than 100 lenders. “I’ve run into this situation with a few different lenders. They are handling loans in 11 different states, and they are not familiar with the regulations in all of them. They are making a $500,000 loan and think they need $500,000 of insurance. You have to track down a senior manager somewhere and hope that they know the rules.”
Pete Moraga, a spokesman for the Insurance Information Network of California, has also heard from insurers that this is happening. He said he suspects it is tied to the proliferation of zero-down, interest-only loans in Southern California as lenders seek extra protection for their investments on ever-riskier deals.
“Lenders are probably getting worried that people will just throw them keys after a fire, write it off and say, ‘You own the property. Do whatever you want,’ ” he said. But he adds that they are wasting their time by demanding more insurance. The policies simply won’t help them.
Lenders deny any of this is intentional. Pam Marsh, a spokeswoman for Miller’s lender, Pasadena-based IndyMac Bank, said her case was caused by a simple employee mistake, and the company has strengthened its training policies to make sure it doesn’t happen again. And the California Mortgage Bankers Assn. said the issue hasn’t even been on its radar. “This is the first I have heard of it being a problem,” said board member Rich Gale.
But state regulators are getting calls from consumers confronted with the demand. “Our department provides them with a copy of the [law] and recommends they contact their lender and provide that code section,” said Susie Wong, spokeswoman for the state Department of Corporations. The law allows consumers to recover damages and attorney fees.
Those who don’t know enough to contact the department, however, will find themselves at the mercy of their insurance agent, who may or may not advise them against buying the extra insurance.
“There are insurance companies that would just not question it,” said Prather, the Cerritos mortgage broker. “I would bet the majority of consumers that are running into this actually buy the extra insurance. The typical consumer has no clue and will just go along with the flow.”
Department of Insurance spokesman Norman Williams said there is no law that prohibits an insurance company from selling such a policy if the consumer asks for it. Insurers, however, say their agents will urge consumers only to buy the coverage they need.
Carol Thorp, a spokeswoman for the Automobile Club of Southern California, said that agents there will tell their customers not to buy insurance they don’t need. AAA agents will occasionally give the customer a copy of the law, section 2955.5 of the California Civil Code, to show the lender.
Sometimes even that is not enough. Miller’s loan processor and a customer service official at IndyMac both told her she was mistaken after she challenged their demand for extra insurance. So Miller just bought the policy, paid a $602 annual premium as part of her closing costs and took her case to the Better Business Bureau after the loan closed. It wasn’t until months later, and several letters back and forth between Miller and the lender, that the company finally admitted to making a mistake and refunded her $294, plus an extra $200 for her troubles.
“If I hadn’t been so aggressive, I would still be paying for all that insurance I didn’t need,” she said. “So many people don’t have time to do all that.”
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Owners have the law on their side
One way for homeowners to tell if they are being asked by a lender to carry excessive insurance is to find out how much it would cost to rebuild the home.
A free online resource is www.building-cost.net, where the publisher of the National Building Cost Manual has created a thorough calculator that enables users to compute house construction costs in various cities.
Also, talk to a few insurance agents. Instead of telling them how much insurance the lender is requiring, start by asking how much coverage is needed. The insurers should give an accurate assessment of what it would take to rebuild.
If a lender demands a home be covered for more than its replacement value, show the mortgage company a copy of section 2955.5 of the California Civil Code, which clearly states that this is illegal. The code can be found at www.leginfo.ca.gov/calaw.html. Click the box next to “Civil Code” and in the search box at the bottom of the page, type in “2955.5.”
Consumers unable to resolve the issue with the lender can file a complaint with the California Department of Corporations. The department can be reached at (866) ASK-CORP. Complaint forms are available online at www.corp.ca.gov/comp/complist.htm.
Another option is to contact the Better Business Bureau at (909) 835-6064 or www.labbb.org.
