Lender placed insurance (LPI), also known as forced placed insurance, is a policy that a lender or mortgage servicer buys on behalf of a borrower when the latter’s own property insurance lapses or is deemed insufficient. While this might seem like a convenient safety net for commercial building owners, LPI can be a financial and operational burden. Understanding why LPI is a bad idea and exploring strategies to avoid it can help commercial property owners maintain control over their insurance costs and coverage.
Why do lenders care if a property is adequately insured?
Lenders care about property insurance because it protects their investment. If the property is damaged or destroyed, insurance helps cover repair or replacement costs, ensuring that the property’s value remains intact. Without insurance, the borrower might face significant financial hardship, which could impact their ability to repay the loan. In essence, insurance reduces the risk for the lender and ensures that the collateral securing the loan is protected.
Because many mortgage lenders are also members of the Federal Deposit Insurance Company, they are required to ensure that lending activity is being conducted in a manner that complies with applicable consumer protection laws. For lenders, having a properly insured home or commercial building is important on two fronts. Protecting their loan investment as well as keeping the lender compliant with the terms of its membership within the FDIC.
Why Lender Placed Insurance is a Bad Idea
- High Premiums: Lender placed insurance is typically much more expensive than standard property insurance. Lenders pass on the cost to the borrower, often with significant markups. The inflated premiums can strain the financial resources of a commercial property owner, leading to increased operational costs and reduced profitability.
- Limited Coverage: Despite the high cost, LPI often provides less comprehensive coverage compared to standard insurance policies. It typically covers only the lender’s interest in the property, excluding coverage for the borrower’s personal property, liability, or business interruption. This limited protection leaves property owners vulnerable to substantial financial losses in the event of a disaster.
- Lack of Control: With LPI, property owners have little to no say in the terms and conditions of the insurance policy. The lender selects the insurer and dictates the coverage limits, which may not align with the owner’s needs or risk management strategy. This lack of control can result in inadequate coverage and increased exposure to risk.
- Negative Impact on Credit: The added expense of LPI can lead to higher monthly mortgage payments. If a property owner struggles to meet these increased payments, it can negatively impact their credit score, making it more difficult to secure favorable financing in the future.
- Administrative Burden: Disputing or replacing LPI involves navigating a complex and time-consuming process. Property owners must provide proof of adequate insurance coverage to the lender and may face delays or bureaucratic obstacles. This administrative burden can divert time and resources away from core business operations.
How to Avoid Lender Placed Insurance
- Maintain Adequate Coverage: The most effective way to avoid LPI is to ensure continuous and adequate property insurance coverage. Regularly review and update your insurance policies to reflect the current value of your property and any changes in your risk profile. Working with a knowledgeable insurance broker can help you secure comprehensive coverage tailored to your specific needs.
- Timely Payments: Ensure that insurance premiums are paid on time to avoid policy lapses. Set up automatic payments or reminders to stay on top of due dates. Prompt payment not only prevents lapses but also demonstrates financial responsibility to lenders.
- Communicate with Your Lender: Keep your lender informed about your insurance status. Provide them with proof of coverage, including the insurer’s name, policy number, and coverage details. Proactive communication can prevent misunderstandings and ensure that your lender is aware of your compliance with insurance requirements.
- Bundle Insurance Policies: Consider bundling your property insurance with other types of coverage, such as liability or business interruption insurance. Bundling can often result in discounts and streamline the management of multiple policies, reducing the risk of lapses.
- Work with a Reputable Broker: A reputable insurance broker can help you navigate the complexities of commercial property insurance. They can provide valuable advice, negotiate better terms, and ensure that your coverage meets lender requirements. An experienced broker can also assist in resolving disputes with lenders regarding insurance coverage.
- Regular Policy Reviews: Conduct annual reviews of your insurance policies to ensure they continue to meet your needs. Changes in your property’s value, business operations, or the regulatory environment may necessitate adjustments to your coverage. Regular reviews help you stay ahead of potential issues and maintain compliance with lender requirements.
While lender placed insurance may seem like a convenient fallback, its high costs, limited coverage, and lack of control make it a poor choice for commercial property owners. By maintaining adequate coverage, ensuring timely payments, communicating with your lender, bundling policies, working with a reputable broker, and conducting regular policy reviews, you can avoid the pitfalls of LPI and protect your commercial investment more effectively.
