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Tuesday, March 5, 2024

Home Insurance for Paid-Off Properties: When to Get It and When to Skip It

In my message, the percentage of homeowners who pay in cash, a reader asked my opinion about getting home insurance for paid-off properties. Paid-off property means a property you bought with cash or a property you own after paying off the mortgage.

This is a dilemma I struggled with after recently paying cash for my house. I wanted to save money on home insurance, but I also wanted my newly acquired property to be protected in the event of a disaster.

Home insurance is not required by law, but check your country’s legislation. Only if you take out a mortgage to buy a house will your lender require that you have home insurance until the loan is paid off. If you refuse to get home insurance, chances are you will will not qualify for a mortgage.

Ultimately, I decided to get home insurance because I was making the most expensive home purchase of my life. The last thing I wanted to do was put a large percentage of my equity into a house and have it destroyed.

Let me walk you through my thought process on whether you should get home insurance after paying off your mortgage or buying a house with all the money. By the end of this article, you should be able to make a more informed decision.

Home insurance needs for paid off properties

I will first address the question of whether you should take out home insurance with a value of the house as a percentage of the equity point of view.

Again, the key assumption is the house is paid off. If you have a mortgage, you have no choice but to take out home insurance. Below is a graph showing that approximately 42% of American homeowners own their home free and clear.

1) Get home insurance if the value of the house is greater than 30% of your net worth

Unless your property is worth less than 30% of your net worth, I would do that not risk of skipping home insurance. If you own real estate, you have to think in disaster scenarios. As your house burns down completely in a fire and you are not insured, are you doing well financially?

You don’t just have to worry about the costs of rebuilding your home. It is also the cost of renting another house while it is being rebuilt. You will also likely lose many valuable personal items in your destroyed home.

During the disaster phase, without home insurance, you may have to sell other assets at a discount to keep you and your family afloat.

Owning a home worth more than 30% of your equity without home insurance is too risky a proposition.

2) Consider foregoing home insurance once your home is less than 10% of your net worth

Once the value of your home is less than 10% of your net worth, it may be okay to save on home insurance by skipping it. You live frugally and probably have a huge cash flow and savings. For reference, the typical American has more than 70% of their wealth in their home.

If your house burns down, it will hurt, but it won’t ruin you financially. And what are the chances of a complete disaster? Not too high. It’s common to lose 10% or more of the value of your stock holdings in a given year. As a result, losing 10% of your wealth in a natural disaster will feel normal.

Based on my 20+ years of homeownership, 10% is the magic threshold where you stop worrying too much about loss. For example, when I stupidly spent 30% of my net worth on one holiday accommodation that I didn’t needI worried a lot during the Global financial crisis. But today the vacation property is worth less than 3% of my net worth and I don’t worry if it burns down or underperforms.

The gray area in whether or not to take out home insurance for a paid-off house is when its value as a percentage of your assets is in between 10.1% – 29.9%. Personally, I would still get home insurance as long as my house is worth 20% or more of my net worth.

3) A compromise to save money – get an actual cash value policy instead

I’m always looking to save money, especially now that I am house rich, money poor. There are two types of home insurance that you can take out:

  1. Replacement Cost Value (RCV) – Comprehensive home insurance that is more expensive because it replaces the cost of your home and personal items at current market value.
  2. Actual Cash Value (ACV) – A cheaper home insurance policy that replaces the value of your destroyed home and personal items after depreciation.

The most common example used to explain the difference is a roof.

Replacement costs Home insurance will cover the full cost of replacing the roof at the current price, even if it is 30 years old. The roof could cost $35,000 today.

Actual cash value home insurance replaces the actual value of the roof after 30 years of use. The roof might only be worth $5,000 today, so that’s the amount your ACV policy will pay out.

If you want to save money and get “disaster home insurance,” you can afford a cheaper ACV policy. Based on my experience shopping around, an ACV policy can cost 30% – 50% less than an RCV policy.

Here is a more detailed post about the difference between RCV and ACV home insurance.

Using time as a variable for whether or not to purchase home insurance for a paid-off property

In addition to thinking about the risk of home loss as a percentage of equity, think about time as an important variable in whether or not to get home insurance once your house is paid off.

1) Take out home insurance during the first year of homeownership

You won’t know the full risks and nuances of owning your home until you actually live in it. That’s why even though you have a paid-off property, I recommend getting home insurance for the first year.

After your first year of homeownership, you go through all the seasons. You can experience the rain, wind and possible fires in your neighborhood. You will also be informed of nearby activities in terms of traffic, thefts and other disturbances caused by others.

With one year’s worth of data, you can make a more informed decision about whether you need home insurance or not. Please take the time to understand what home insurance entails.

2) After living in your house for three years, you know better

Living in your home for one year is probably not long enough to get the most complete picture possible of the risks of your home. But after you’ve lived in your paid-off home for three years, you can make a better decision about whether to keep or end your home insurance coverage.

The more severe the weather and home disruptions during your first period of residence, the better you can make the best possible decision about home insurance. If you live in an area prone to natural disasters such as fire or flooding, then you should be more inclined to take out home insurance.

Home insurance as the owner of a rental property

As the owner of three paid-off rental properties, I feel better about having rental property insurance because I don’t know what my tenants are doing on a daily basis. Since I rented out a rental property to a bunch of guys who said yes take care of the property, but did not“I’ve been more careful.

It is only natural that homeowners take more care of their property than renters. Therefore, owning home insurance for a rental property offers more value than building insurance for a primary residence. Rental property insurance provides peace of mind that is worth a lot!

That said, I’m considering canceling my Lake Tahoe vacation insurance now that the mortgage is paid off. The property is located in an apartment complex/hotel with many safety features. It is also a non-smoking unit.

On the other hand, since home insurance is an expense for a rental property, the cost is not as high as home insurance for a primary residence, which is not deductible.

One final cost-saving strategy for home insurance

If you have a… newly renovated home, you’ll get more bang for your buck by purchasing actual cash value (ACV) home insurance. The reason for this is that your house depreciates less because it is new or newer. The value of a one-year-old roof is closer in cost to a new roof than a 30-year-old roof.

So, a money-saving strategy is to get an ACV policy for the first 10-20 years you own your paid-off home. When you start to feel like your house is getting old, switch to home replacement cost insurance (RCV). This way, if your house burns down, your 30-year-old stove and bathtub will be replaced with brand new ones.

A couple I know went to Lake Tahoe for two weeks during a snowstorm. Unbeknownst to them, the roof of their house leaked constantly while they were away, destroying their bedrooms and kitchen.

Fortunately, they still thought about doing a bowel renewal. Their RCV home insurance paid for the entire renovation, including the eight months’ rent they had to pay to move elsewhere! It was as if their RCV policy paid for another renovation.

Home insurance costs increase over time

I own property that I have purchased since 2003. Fortunately, I have yet to make a home insurance claim on any of my properties. If there was damage, the repair costs were below my deductible, so I just paid out of pocket. High deductibles are how home insurance companies keep claims at bay.

If I didn’t need home insurance due to having mortgages, I might have saved $100,000 in home insurance premiums by now. That $100,000 in savings could have been invested or set aside to pay for any future damage to my property.

Home insurance companies are highly profitable for good reason. They receive more home insurance premiums than they pay out. Therefore, it is best to invest in home insurance if you are paying for home insurance.

Even though you have a paid-off house, you should consider liability coverage. If you have a reckless teenager or throw a lot of parties, liability coverage is important. It helps protect your personal assets from costly lawsuits.

In addition to home insurance, you can also look into getting one overarching policy for more liability protection. The richer you become, the more you need to protect your assets.

My home insurance savings plan for a paid-off house

The house I just bought with cash is less than 30% of my net worth. That’s why I’m going to take out Actual Cash Value (ACV) home insurance for the next three years and then reassess it. An ACV policy gives me peace of mind in the event of a disaster and also gives me the satisfaction of saving ~$1200 per year on home insurance premiums.

My net worth would have to grow by ~150% for my house to reach 10% of my net worth. As a result, I will probably have ACV home insurance for at least 15 more years. And over time I’ll probably have to keep it update my coverage because of the hopeful increase in the value of my house.

If my wealth does indeed grow 150% in 15 years, I will have no problem dropping home insurance coverage. On the other hand, if my wealth really grows that much, paying for home insurance won’t feel like a financial burden.

With a paid-off property, you have to decide how much peace of mind is worth to you. At this moment, peace of mind is worth a lot to me and that is why I will continue to take out home insurance for the foreseeable future.

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