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Foreclosure and home insurance: What you need to know

If you're on the verge of losing your home to foreclosure, you may be tempted to stop paying for home insurance since the house won't be your concern for much longer. But while you may think you'll save money by canceling your home insurance policy early, such a move could actually cost you more in the long run.

What is foreclosure?

Foreclosure occurs when you can't keep up with the mortgage payments on your home and your lender takes back possession of the house. Since legal proceedings are involved, a foreclosure can be a lengthy process. For example, in the state of Ohio, the foreclosure process can take between six and 18 months, according to the Ohio Attorney General's Office. During that time, you may be able to continue living in your home.

foreclosure and home insurance Some people may decide to stop paying for home insurance since they are no longer making mortgage payments. Others may let their home insurance policy lapse because of financial troubles. "If you can't make your house payments, you probably can't make your home insurance payments either," says Ron Fredrickson, manager of the Oregon Insurance Division Consumer Advocacy Unit.

But that's not a good idea.  

Typically the bank will contact you once the foreclosure is complete, letting you know when you must vacate the premises. Don't stop paying for your home insurance until you receive this notice. If you don't wait, it "would be one of the worst things you can do," says Robert Scott, a partner with Irvine, Calif.-based Advocate Law Group. 

Here's why a premature cancellation could come back to haunt you.

Why you shouldn't stop paying for home insurance until your foreclosure is final

1. Your name is still on the title.

Until a foreclosure is final, you technically are still the owner of the house.

If a loss occurred while the homeowner still had possession of the home, his or her policy would cover the loss, says Vincent Plymell, a spokesman for the Colorado Department of Regulatory Agencies. If the loss occurred after the foreclosure was finalized, the lender would need to have purchased a new policy that would cover it, Plymell adds.

In all cases, including those of foreclosure, lenders often stipulate in loan agreements that any home insurance settlements for property damage be made payable to both the homeowner and the lender, says Jerry Hagins, spokesman for the Texas Department of Insurance. So if a loss occurs, the lender has to sign off on the check, as well, ensuring the money is used as intended.

2. You could end up with a higher premium.

Before you cancel any home insurance policy, take a look at your loan documents. "The loan agreements typically require the borrower to maintain insurance," Hagins says.

Once you stop paying for home insurance, your home insurance company would let your lender know the policy was canceled. Most mortgage loan agreements have a clause in place that allows the lender to purchase what's known as a force-placed insurance policy if the homeowner stops paying for home insurance. The lender can then charge the homeowner for the force-placed policy.

But you don't want to go this route, Scott says, because force-placed insurance policies typically cost more than a regular home insurance policy. A study by New York's Department of Financial Services found that force-placed policies can cost two to 10 times more than traditional home insurance policies, even though they often provide less extensive coverage. "It's expensive for what you get," Scott says, and it only covers the lender's interest -- which is the property itself and not the possessions within it.

3. You may be liable for certain damages.

Another reason you should keep paying for home insurance is because a force-placed policy may not offer you full coverage. A force-placed policy typically will include hazard coverage, which means it provides protections for certain perils such as fire and wind damage. But it might not have some of the other protections that are found in traditional home insurance policies.

For example, your belongings might not be covered -- so if your home is burglarized or if your property inside the house is destroyed in a fire, you might suffer the financial loss. A force-placed policy might also lack owner liability coverage, so if a visitor to your home fell down the steps, broke a leg and sued you, you might find yourself responsible for his or her medical expenses.

From the first day you own your home to the last, you want to make sure a home insurance policy is in effect -- even if it ends in foreclosure. "You can have just two days with no insurance and something inevitably could go wrong," Scott says.

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