I live in the bay area, CA where there are many earthquakes. I was recently reading: http://blog.petetheplanner.com/financially-what-happens-when-your-house-burns-down/ which stated that your home owners (fire etc) insurance goes first to your mortgage and then to you.
The value proposition of buying earthquake insurance in this context seemed to not make sense to me.
It is my understanding that mortgages require home owners insurance (at least in my area) but do not require earthquake insurance.
Here are my assumptions:
- Earthquake insurance is not required by lender
- It's quite expensive as well
- Most other homeowners are not buying it (reason for slower price recovery)
- A home owner in the area would put maybe 20% down on a loan
- In the case of a catastrophic earthquake (enough to destroy a home past the deductible) prices would drop significantly, the housing market would be significantly impacted.
- Earthquake insurance insures the value of the house not the land value (aka purchase price of the home before the earthquake) Ex bay area houses might cost 200k to build but sell for a million.
- So would earthquake insurance pay out go to the lender?
- If that's the case and house prices have fallen significantly isn't the borrower just insuring their ability to pay back the lender vs. say in a traditional house fire where the area (land) would retain value and they might rebuild and not lose significant value? Ex if they didn't pay for the insurance they would probably be forced to walk away from the property (assuming large losses).
I guess I'm trying to figure out the values of earthquake insurance for a home buyer.
Fundamentally it seems to me that a major earthquake would change the value of the actual area significantly in a way a fire or flood would not.
Here's my example scenario:
House fire: A house burns down and the insurance company pays the cost to rebuild and the family's living expenses while that occurs. Property values do not change. Deductible cost lost.
Major earthquake (made up prices for simplicity): Nearly all of the buildings are severely damaged. The original cost to buy a house in the area is 100k. The buyer buys with 20% down (mortgage of 80k). The cost to build a house 50k. Insurance pays 50 + living expenses. 50 is applied to the mortgage. The home owner still owes 30k, and the land has little to no value.
What am I missing? It seems to me that with or without insurance the home buyer will never see a cent. Is the home buyer just paying to prevent a mortgage default? It seems like a pretty high cost to do so.