Home Insurance Needs For Paid Off Properties With No Mortgage

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In my post, the percentage of homeowners who pay cash, a reader asked my opinion on having home insurance for paid-off properties. Paid off properties include a property you purchased with all cash or a property you own after paying off the mortgage.

This is a dilemma I wrestled with after recently paying cash for my home. I wanted to save money on home insurance, but I also wanted my newly acquired asset to be protected in case of a disaster.

Home insurance isn’t required by law, but double check your state’s law anyway. Only if you take out a mortgage to buy a house will your lender require you to have home insurance until the loan is paid off. If you refuse to get home insurance, then you most likely won’t 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 sink a large percentage of my net worth in a house and have it destroyed.

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

Home Insurance Needs For Paid Off Properties

I’m going to first tackle the question of whether to get home insurance from a home’s value as a percentage of net worth point of view. Again, the key assumption is the house has been paid off.

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

Unless your property is worth less than 30% of your net worth, I would not risk skipping home insurance even if it’s paid off. You must think in disaster scenarios when you own property. If your house completely burns down in a fire and you have no insurance, will you be OK financially?

It’s not just the cost to rebuild your home that you need to worry about. It’s also the cost to rent another home while it’s being rebuilt. You will likely also lose a lot of valuable personal items in your destroyed home.

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

Owning a home that’s worth greater than 30% of your net worth without home insurance is too risky of a proposition.

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

Once your home’s value is less than 10% of your net worth, it’s OK to save on home insurance by skipping it. You’re living frugally and probably have tremendous cash flow and savings. For reference, the typical American has greater than 70% of their net worth in their home.

If your house burns down, it’s going to hurt, but it won’t ruin you financially. It’s common to lose 10% or more in the value of your stock holdings in any given year. As a result, losing 10% of your net worth in a natural disaster will feel like par for the course.

Based on my 20+ years of homeownership 10% is the magical threshold where you no longer worry much about loss. For example, when I stupidly spent 30% of my net worth on a vacation property I didn’t need, I 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 grey area of whether to get home insurance on a paid off home is when its value as a percentage of your net worth is between 10.1% – 29.9%. Personally, I’d still get home insurance so long as my home 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’m house rich, cash poor. There are two types of home insurance policies you can get:

  1. Replacement Cost Value (RCV) – A comprehensive home insurance policy that is more expensive because it replaces the cost of your home and personal items at today’s 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 Cost Value home insurance will pay for the full cost of replacing the roof at today’s price, even if it’s 30 years old. The roof could cost $35,000 today.

Actual Cash Value home insurance will replace the actual value of the roof after 30 years of usage. The roof could be worth only $5,000 today, so that is the amount your ACV policy will pay out.

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

Here’s a more comprehensive post on the difference between RCV and ACV home insurance policies.

Using Time As A Variable For Whether To Get Home Insurance For A Paid Off Property

Besides thinking about housing loss risk as a percentage of net worth, think about time as a key variable for whether to get home insurance or not if your house is paid off.

1) During the first year of homeownership get home insurance

You will not know the full risks or nuances of owning your home until you actually live in it. Therefore, despite having a paid off property, I recommend having home insurance for the first year.

After the first year of homeownership, you will go through all the seasons. You’ll be able to experience the rains, winds, and potential fires in your neighborhood. You’ll also be made aware of neighborhood activity in terms of traffic, thefts, and other disturbances caused by people.

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

2) After three years of living in your home

One year of living in your home is probably not long enough to get the most comprehensive picture of your home’s risks. But after living in your paid off home for three years, you can make a better decision on whether to keep or drop your home insurance coverage.

The more violent the weather and home disturbances during your initial living period, the better in order to 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 have home insurance.

Home Insurance As A Rental Property Owner

As an owner of three paid off rental properties, I feel better having rental property insurance because I don’t know what my tenants are up to on a daily basis. Ever since renting out a main rental property to a bunch of guys who said they’d take care of the property but didn’t, I’ve been more cautious.

It’s only natural for homeowners to care more for their property than tenants. Therefore, owning home insurance on a rental property provides more value than owning home insurance on a primary residence. The rental property home insurance provides peace of mind, which is worth a lot!

That said, I’m considering dropping my vacation property insurance in Lake Tahoe now that the mortgage is paid off. The property is in a condo building / hotel with a lot of safety features. It is also a non-smoking unit.

Then again, given home insurance is a rental property expense, the cost isn’t as high as home insurance for a primary residence, which isn’t deductible.

One Final Home Insurance Cost Saving Strategy

If you have a recently remodeled home, you get better bang for your buck by getting an Actual Cash Value (ACV) home insurance policy. The reason why is because your home has less depreciation because it’s 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.

Hence, one money-saving strategy is to get an ACV policy for the first 10-20 years of owning your paid off home. When you start to feel your home is getting dated, switch over to a Replacement Cost Value (RCV) home insurance policy. This way, if your house burns down, your 30-year old range and bathtub get replaced with brand new ones!

One couple I know went to Lake Tahoe for two weeks during a blizzard. Unbeknownst to them, while they were away, their home’s roof leaked the entire time, destroying their bedrooms and kitchen.

Thankfully, they were thinking about doing a gut remodel anyway. Their RCV home insurance policy paid for the entire remodel, including the eight months of rent they had to pay for living elsewhere! It was as if their RCV policy paid for a new remodel.

Home Insurance Costs Add Up Over Time

I’ve owned real estate that I’ve purchased since 2003. Thankfully, I have yet to file a home insurance claim on any one of my properties. When there was damage, the cost to fix was below my deductible, so I just paid out of pocket.

If I wasn’t required to have home insurance due to having mortgages, I may 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 damages my properties may incur.

Despite having a paid off home, you should also consider liability coverage. If you have a reckless teenager or throw a lot of parties, liability coverage helps you protect your personal assets from costly lawsuits and can be increased as your assets grow.

Beyond home insurance, look into getting an umbrella policy for more liability protection.

My Home Insurance Savings Plan For A Paid Off House

The home I just bought with cash is less than 30% of my net worth. Therefore, I’m going to own an Actual Cash Value (ACV) home insurance policy for the next three years and then reassess. An ACV policy gives me peace of mind in case of a disaster as well as the satisfaction that I’m saving ~$1,200 a year in home insurance premiums.

My net worth would have to grow by ~150% for my home to get to 10% of my net worth. As a result, I will probably have an ACV home insurance policy for at least another 15 years. And over time, I will likely need to keep updating my coverage due to the hopeful increase in my home’s value.

If in 15 years, my net worth does indeed grow by 150%, I won’t have a problem dropping home insurance coverage. Then again, if my net worth really grows by 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 the moment, peace of mind is worth a lot to me, which is why I’ll continue to have home insurance for the foreseeable future.

Reader Questions

If you have a paid off property, what are your thoughts on getting home insurance? What is your experience with filing a home insurance claim? Besides percentage of net worth and time, what other metrics have you used to determine whether to get home insurance or not?

Suggestions

To invest in real estate passively without having to think about home insurance needs, check out Fundrise. Fundrise offers private real estate funds that predominantly invest in residential and industrial properties in the Sunbelt region. Financial Samurai is an investor in Fundrise.

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