Why Property Insurance Requirements Matter
Fannie Mae sets strict insurance standards because your home secures the mortgage. If disaster strikes and the property lacks adequate coverage, both you and the lender face financial loss. These rules ensure your property can be rebuilt to its original condition without leaving you underwater on your loan.
The guidelines protect against the most common property risks. Fire, wind, and hail cause the majority of homeowner insurance claims. The required coverage list reads like a catalog of disasters that could destroy your home's value overnight.
Coverage Requirements for Single-Family Homes
Your insurance policy must cover ten specific perils. Fire and lightning top the list, followed by windstorm and hail. The policy must also protect against explosion, riot, civil commotion, aircraft damage, vehicle damage, and smoke damage.
If your primary policy excludes any of these perils, you need a separate policy to cover the gap. This happens most often in high-risk areas where insurers exclude wind or hail damage from standard policies.
Say you live in tornado alley and your insurer excludes windstorm coverage from your homeowner's policy. You would need to buy separate wind insurance to meet Fannie Mae requirements. Both policies together must cover all ten required perils.
How Much Coverage You Need
The coverage calculation follows a specific formula. Your insurance must equal the higher of two amounts: your current loan balance or 80% of your home's replacement cost value.
Here's how it works in practice. Your loan balance is $200,000 and your home's replacement cost is $250,000. Eighty percent of replacement cost equals $200,000. Since both amounts are equal, you need $200,000 in coverage.
Now imagine your loan balance drops to $150,000 but replacement cost stays at $250,000. Eighty percent of replacement cost is still $200,000, which exceeds your loan balance. You need $200,000 in coverage, not just $150,000.
The rule protects you from being underinsured as you pay down your mortgage. Without this requirement, you might carry less coverage than needed to rebuild your home.
Replacement Cost vs. Actual Cash Value
Your policy must settle claims on replacement cost basis. This means the insurer pays to rebuild or repair your home with materials of like kind and quality, regardless of depreciation.
Actual cash value policies subtract depreciation from claim payments. If your 10-year-old roof suffers hail damage, an actual cash value policy might pay only 50% of replacement cost. A replacement cost policy pays the full amount to install a new roof.
Fannie Mae rejects any policy that limits, depreciates, or reduces claim payments below replacement cost. The language matters here. Read your policy declarations page carefully to confirm replacement cost coverage.
Deductible Limits
Your deductible for fire, water, or wind damage cannot exceed 5% of your dwelling coverage limit. This rule prevents insurers from shifting too much risk to homeowners through high deductibles.
If you carry $300,000 in dwelling coverage, your maximum deductible is $15,000. A $20,000 deductible would violate Fannie Mae guidelines, even if you're comfortable with that risk level.
Water damage refers to burst pipes or appliance leaks, not flood damage. Flood insurance operates under separate rules and different deductible limits.
Required Documentation
Your lender needs specific documents to verify insurance compliance. The insurance binder or declarations page shows coverage amounts, covered perils, and deductible amounts. This document must clearly state replacement cost coverage.
For replacement cost verification, lenders accept the insurance company's replacement cost estimator or an insurance risk appraisal. They may also accept a statement from the property insurer, an independent insurance specialist, or another qualified professional.
The insurance agent's verbal assurance doesn't satisfy underwriting requirements. You need written documentation that shows exact coverage amounts and policy terms.
Condo and Townhome Complications
Condominiums and planned unit developments create more complex insurance scenarios. The homeowners association typically carries master insurance covering building exteriors and common areas. Individual owners need HO-6 policies covering their unit interiors and personal property.
The association's master policy must cover 100% of the project's replacement cost value. This includes all buildings, common elements, and residential structures. The policy must use replacement cost settlement and special coverage form language.
If you're buying a condo, your lender will review both the master policy and your individual HO-6 policy. Both must meet Fannie Mae standards. The master policy's adequacy affects your loan eligibility, even though you don't control that coverage.
When Deductibles Exceed Limits
Some geographic areas face special risks that push deductibles above normal limits. Hurricane or earthquake deductibles often exceed the 5% maximum allowed under standard guidelines.
If the master policy deductible exceeds 5% due to geographic perils, your individual HO-6 policy can fill the gap. Your policy must cover the same perils as the master policy and include sufficient coverage to bring the effective deductible down to 5%.
Here's an example. A 20-unit condo building carries $6 million in master coverage with a $40,000 per-unit hurricane deductible. That creates a 13.3% effective deductible, well above the 5% limit. Each unit owner needs an HO-6 policy covering at least $25,000 to bring the effective deductible down to the required 5%.
Vacant Property Considerations
Lenders must ensure adequate coverage remains in force even when properties become vacant or unoccupied. Many insurance policies reduce coverage or exclude certain perils for vacant properties.
If you're relocating before selling your current home, notify your insurance company about the vacancy. The lender must also receive notice to preserve its rights under the policy. Failure to report vacancy changes can void coverage when you need it most.
Some insurers require separate vacant property policies after 30 or 60 days of vacancy. These policies typically cost more and provide less coverage than standard homeowner's insurance.
Common Problems That Delay Closing
Insurance issues cause frequent closing delays. The most common problem involves coverage amounts that fall short of requirements. Your agent calculates coverage based on market value, but Fannie Mae requires replacement cost value, which is often higher.
Actual cash value policies create another frequent stumbling block. Many homeowners don't realize their policy settles claims on depreciated value until the lender reviews their coverage. Switching to replacement cost coverage may require a new policy or endorsement.
Excluded perils also cause problems. Some insurers exclude wind or hail damage in high-risk areas. Others exclude water damage from certain sources. Review your policy exclusions carefully and arrange separate coverage for any excluded required perils.
References
For the official guidelines, see 4703.2: Minimum property insurance types and amounts in the Fannie Mae Selling Guide.
Mortgage guidelines change. Stay current.
Fannie Mae and Freddie Mac update their rules several times a year. Get notified when changes affect your mortgage eligibility, required documents, or loan terms.
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Original Freddie Mac Guideline Text
(a)
1- to 4-unit properties
At a minimum, the insurable improvements on the Mortgaged Premises must be insured for loss or damage from:
Damage by smoke
If any of the preceding perils is excluded from the primary insurance policy, coverage of the excluded peril must be provided through a secondary insurance policy.
The deductible for fire, water (not caused by flooding) or wind damage to the insured improvements (generally designated as “dwelling” in the insurance policy) may not exceed 5 percent of the limit maintained for dwelling coverage.
Insurance policies must provide for claims to be settled on a replacement cost basis. Policies that (1) provide for claims to be settled on an actual cash value basis, or (2) limit, depreciate, reduce or otherwise settle losses for less than a replacement cost basis are not eligible.
The insurance limits must at least equal the higher of:
The UPB of the Mortgage
80% of the full replacement cost value (RCV) of the insurable improvements as of the current insurance policy effective date
The coverage required in accordance with the above formula must not exceed the replacement cost of the insurable improvements, even when the UPB of the Mortgage exceeds such replacement cost.
The table below describes how to calculate the required amount of insurance.
1
Determine the UPB and the RCV.
2
If the RCV is less than the UPB, the required insurance coverage is the RCV, and no further calculation is required. If the RCV is greater than the UPB, go to step 3.
3
If the RCV is greater than the UPB, calculate 80% of the RCV and then go to step 4 or 5.
4
If this calculation is equal to or less than the UPB, the UPB is the amount of coverage required or
5
If this calculation is greater than the UPB, the 80% calculation is the amount of coverage required.
Examples:
Property A:
Property B:
80% of the RCV is equal to or less than the UPB
Property C:
80% of the RCV is greater than the UPB
$80,000
$90,000
$90,000
$85,000
$80,000
$65,000
80% of replacement cost
$64,000
$72,000
$72,000
$80,000
$80,000
$72,000
Seller/Servicers must verify the RCV in order to complete the calculation above. The verification source may be (1) the replacement cost estimator utilized by the insurance carrier or an insurance risk appraisal; or (2) statement from property insurer, an independent insurance risk specialist, or other professional with appropriate resources to make such a determination.
The Seller/Servicer must ensure that adequate insurance coverage is in force even when the improvements are vacant or unoccupied and must notify all insurers of any such change in occupancy in order to preserve its rights as mortgagee under the applicable insurance policy.
(b)
Planned Unit Developments (PUDs) and ground lease communities
Unit owners within a Planned Unit Development (PUD) and leasehold lessees within a ground lease community with residential properties similar to 1- to 4- unit properties can insure their units individually, provided that the requirements in
Section 4703.2(a)
are met.
If the individual units are covered by insurance purchased by their respective owners or leasehold lessees, the PUD homeowners association or the fee simple landowner/lessor of the ground lease community, the Seller is not required to verify insurance for its Common Elements.
Freddie Mac will also accept a master insurance policy covering all units in the PUD or ground lease community if called for in the PUD’s governing documents or in the ground lease. The Seller/Servicer must confirm the master insurance policy limit covers 100% of the replacement cost value of the units, as of the current insurance policy effective date, but is not required to verify if a master insurance policy provides insurance for Common Elements. The verification source may be (1) the replacement cost estimator utilized by the insurance carrier or the project's insurance risk appraisal; or (2) statement from property insurer, an independent insurance risk specialist, or other professional with appropriate resources to make such a determination.
The master insurance policy must provide for claims to be settled on a replacement cost basis. Policies that (1) provide for claims to be settled on an actual cash value basis, or (2) limit, depreciate, reduce or otherwise settle losses for less than a replacement cost basis are not eligible.
The master insurance policy must be written on a special coverage form or equivalent.
The PUD homeowners association or fee simple landowner/lessor must also obtain any additional coverage commonly required by private mortgage investors for developments similar in construction, location and use, including the following:
Inflation guard endorsement – this endorsement is required when it is applicable to the coverage and available in the insurance market
Building ordinance or law endorsement – this endorsement is not required if the building is legally conforming under current building, zoning or land use laws, or is not available; however, it is required if the enforcement of any law or ordinance results in increased costs such as demolition or loss to the undamaged portions of the building and the coverage is available in the insurance market
Steam boiler and machinery or equipment breakdown endorsement – this endorsement is required if a building in the project has a central heating ventilation and cooling (HVAC) system and the coverage is available in the insurance market
The insurance limit per covered mechanical breakdown or equipment failure must equal the lesser of:
100% of the replacement cost of the building housing the equipment, or
$2 million
If a higher limit is required by private mortgage investors for PUDs similar in construction, location and use, the PUD homeowners association must maintain the higher insurance limit.
The deductible for fire, water (not caused by flooding) or wind damage to the insured improvements (generally designated as “building” in the insurance policy) may not exceed 5% of the limit maintained for building coverage.
If a master insurance policy deductible exceeds the 5% maximum due to a per unit deductible for named perils specific to a geographic area, the Mortgage is eligible for sale to Freddie Mac if the Borrower’s unit is covered by an owner's HO-6 policy. The Borrower’s owners policy must include the same perils as the master policy, cover master policy assessments levied on the unit owner and carry a sufficient coverage amount to cover the per unit amount over the permissible 5% limit. See
Section 4703.2(c)
below for an example of how to calculate sufficient coverage to meet the 5% maximum deductible requirement.
The insurance policy of the PUD homeowners association or fee simple landowner/lessor of the ground lease community must name the insured in substantially the same language indicated below:
For PUDs:
Association of Owners of the [Name of PUD] Planned Unit Development for the use and benefit of the individual owners (designated by name, if required by law or the governing documents).
For ground lease communities:
[Name of the lessor] of the [Name of the ground lease community] for the use and benefit of the individual lessees (designated by name, if required by law or by the lease).
Mortgages secured by units in a PUD with a master or blanket insurance policy that combines insurance coverage for multiple unaffiliated PUDs are eligible for sale to Freddie Mac provided that each covered PUD has a dedicated policy limit and a specific dedicated deductible that does not exceed the requirements above. Also, the policy must clearly state that each association is a named insured. The policy limit needs to cover the full replacement cost required for the Common Elements, and to the extent required, the units. Additionally, the insurance policy must meet all requirements of the Guide and other Purchase Documents applicable to master insurance policies covering PUDs such as:
The insurance company underwriting the master policy must meet Freddie Mac insurance ratings requirements
The protected perils must include those normally covered in policies for similar types of PUDs; and
If applicable, the building ordinance or law endorsement and/or equipment breakdown endorsement
Projects that are under the same master association and/or share the use of common facilities, whether those facilities are individually owned or owned as part of a master association or development, are considered to be affiliated projects. Multiple projects that do not meet one of these criteria, even if they are under the management of the same management company, are not considered to be affiliated projects.
(c)
Condominiums
The Project Documents will define the insurance requirements for the homeowners association and the individual unit owner in a Condominium Project, including a Detached Condominium Project and a 2- to 4-Unit Condominium Project. The insurance requirements will define the extent to which the homeowners association will insure the individual units and the unit owner responsibility for individual insurance.
There are two acceptable options for unit coverage depending on what the governing documents indicate:
The condominium homeowners association must insure the building and structures in the Condominium Project as well as fixtures, machinery, equipment and supplies maintained for the service of the Condominium Project. To the extent required the homeowners association must also insure fixtures, improvements, alterations and equipment within the individual Condominium Units, regardless of ownership. To the extent the condominium homeowners association’s policy does not cover the interior of the Condominium Unit or the improvements to the Condominium Unit, the Borrower must maintain an HO-6 unit owner policy. Coverage for the HO-6 unit owner policy must be sufficient to repair the Condominium Unit to at least its condition prior to the claim.
If the Project Documents allow Condominium Unit owners to insure their Condominium Units individually, in lieu of a master policy, the Mortgages secured by the Condominium Units are eligible for sale to Freddie Mac provided the requirements in
Section 4703.2(a)
are met. Common Elements must be covered through the condominium homeowners association policy and the homeowners association must maintain all other applicable insurance coverages required in
Chapter 4703
.
The master insurance policy coverage limit must be at least equal to 100% of the replacement cost value of the project's improvements, including Common Elements and residential structures, as of the current insurance policy effective date.
The Seller/Servicer must verify the coverage amount is not less than the minimum required as described above. The verification source may be (1) the replacement cost estimator utilized by the insurance carrier or the project's insurance risk appraisal; or (2) statement from property insurer, an independent insurance risk specialist, or other professional with appropriate resources to make such a determination.
The master insurance policy must provide for claims to be settled on a replacement cost basis. Policies that (1) provide for claims to be settled on an actual cash value basis, or (2) limit, depreciate, reduce or otherwise settle losses for less than a replacement cost basis are not eligible.
The master insurance policy must be written on a special coverage form or equivalent. The condominium homeowners association must also obtain any additional coverage commonly required by private mortgage investors for developments similar in construction, location and use, including the following:
Inflation guard endorsement – this endorsement is required when it is applicable to the coverage and available in the insurance market
Building ordinance or law endorsement – this endorsement is not required if the building is legally conforming under current building, zoning or land use laws, or is not available; however, it is required if the enforcement of any law or ordinance results in increased costs such as demolition or loss to the undamaged portions of the building and the coverage is available in the insurance market
Steam boiler and machinery or equipment breakdown endorsement – this endorsement is required if a building in the project has an HVAC system and the coverage is available in the insurance market
The insurance limit per covered mechanical breakdown or equipment failure must equal the lesser of:
100% of the replacement cost of the building housing the equipment, or
$2 million
If a higher limit is required by private mortgage investors for Condominium Projects similar in construction, location and use, the condominium homeowners association must maintain the higher insurance limits.
Condominium Association Coverage Form or its equivalent, including the following provisions or comparable language:
Recognition of an Insurance Trustee (e.g., “If you name an insurance trustee, we will adjust losses with you, but we will pay the insurance trustee. If we pay the trustee, the payments will satisfy your claims against us.”)
Waiver of Rights of Recovery (e.g., “We waive our rights to recover payment from any unit-owner of the condominium that is shown in the declarations.”)
Unit-owner’s Insurance (e.g., “A unit-owner may have other insurance covering the same property as this insurance. This insurance is intended to be primary, and not to contribute with such other insurance.”)
The condominium homeowners association’s policy deductible for fire, water (not caused by flooding) or wind damage to the insured improvements (generally designated as “building” in the insurance policy) may not exceed 5% of the limit maintained for building coverage.
If the deductible exceeds the 5% maximum due to a per unit deductible for named perils specific to a geographic area, the Mortgage is eligible for sale to Freddie Mac if the Borrower’s unit is covered by an owner’s HO-6 policy. The Borrower’s owner’s policy must include the same perils as the condominium association’s master policy, cover master policy assessments levied on the unit owner and carry a sufficient coverage amount to cover the per unit amount over the permissible 5% limit.
For example:
Condominium association policy limit: $6,000,000
Number of units: 20
Condominium association policy deductible: $80,000
Condominium association separate per unit deductible for ice dam coverage: $40,000
The master deductible of $80,000 is 1.33% of the building coverage ($80,000/$6,000,000) and does not exceed the 5% deductible requirement. However, the per unit deductible is 13.3% (($40,000 x 20 units)/$6,000,000)) which is above the 5% maximum requirement and the policy is not acceptable.
The maximum per unit deductible needed to meet the 5% deductible requirement is $15,000 (($6,000,000/20) x .05)). To be eligible, the unit owner needs an HO-6 policy that would cover the $25,000 per unit coverage ($40,000 - $15,000 = $25,000).
The insurance policy of the condominium homeowners association must name the insured in substantially the same language indicated below:
Association of Owners of the [Name of Condominium Project] Condominium for the use and benefit of the individual owners (designated by name, if required by law or the governing documents).
In the event the HO-6 unit owner policy is required, the policy must include the standard Mortgage clause required in
Section 4703.6
.
Mortgages secured by a Condominium Unit in a Condominium Project with a master insurance policy that combines insurance coverage for multiple unaffiliated Condominium Projects are eligible for sale to Freddie Mac provided that each covered Condominium Project has a dedicated policy limit and a specific dedicated deductible that does not exceed the requirements above. Also, the policy must clearly state that each association is a named insured. The policy limit must cover the full replacement cost of the Common Elements, and to the extent required, the Condominium Units, as of the current insurance policy effective date. Additionally, the insurance policy must meet all requirements of
Chapter 4703
of the Guide and other Purchase Documents applicable to master insurance policies covering Condominium Projects such as:
The insurance company underwriting the master policy must meet Freddie Mac insurance ratings requirements;
The protected perils must include those normally covered in policies for similar types of Condominium Projects; and
If applicable, the building ordinance or law endorsement and/or equipment breakdown endorsement.
Condominium Projects that are under the same master association and/or share the use of common facilities, whether those facilities are individually owned or owned as part of a master association or development, are considered to be affiliated projects. Multiple Condominium Projects that do not meet one of these criteria, even if they are under the management of the same management company, are not considered to be affiliated projects.
(d)
Cooperative Corporations
The Cooperative Corporation must insure the building and structures in the Cooperative Project as well as fixtures, machinery, equipment and supplies maintained for the service of the project. To the extent required by the Cooperative Project Documents, the Cooperative Corporation must also insure fixtures, improvements, alterations and equipment within the individual Cooperative Units, regardless of ownership.
To the extent the Cooperative Corporation policy does not cover the interior of the Cooperative Unit or the improvements to the Cooperative Unit (the fixtures, improvements, alterations and equipment within the individual Cooperative Units), the Borrower must maintain an HO-6 unit owner’s policy. Coverage for the H0-6 unit owner policy must be sufficient to repair the Cooperative Unit to at least its condition prior to the claim. If the Cooperative Corporation policy fully covers the interior or the improvements to the Cooperate Unit, an H0-6 unit owner policy is not required.
The Cooperative Corporation’s master insurance policy coverage limit must be at least equal to 100% of the replacement cost value of the project’s improvements, including common elements and residential structures, as of the current insurance policy effective date.
The Seller/Servicer must verify the coverage amount is not less than the minimum required as described above. The verification source may be the (1) replacement cost estimator utilized by the insurance carrier or the project’s insurance risk appraisal; or (2) statement from property insurer, an independent insurance risk specialist, or other professional with appropriate resources to make such a determination.
The master insurance policy must provide for claims to be settled on a replacement cost basis. Policies that (1) provide for claims to be settled on an actual cash value basis, or (2) limit, depreciate, reduce or otherwise settle losses for less than a replacement cost basis are not eligible.
The master insurance policy must be written on a special coverage form or equivalent.
The Cooperative Corporation must also obtain any additional coverage commonly required by private mortgage investors for Cooperative Projects similar in construction, location, and use, including the following:
Inflation guard endorsement – required when it is applicable to the coverage and available in the insurance market
Building ordinance or law endorsement – not required if the building is legally conforming under current building, zoning or land use laws or is not available; however, it is required if the enforcement of any law or ordinance results in increased costs such as demolition or loss to the undamaged portions of the building and the coverage is available in the insurance market
Steam boiler and machinery or equipment breakdown endorsement – required if a building in the Cooperative Project has a central heating ventilation and cooling system and the coverage is available in the insurance market.
The insurance limit per covered mechanical breakdown or equipment failure must equal the lesser of:
100% of the replacement cost of the building housing the equipment, or
$2 million
The deductible for fire, water (not caused by flooding) or wind damage to the insured improvements (generally designated as "building" in the insurance policy) may not exceed 5% of the limit maintained for building coverage.
If the deductible exceeds the 5% maximum due to a per unit deductible for named perils specific to a geographic area, the Cooperative Share Loan is eligible for sale to Freddie Mac if the Borrower’s unit is covered by an owner’s HO-6 policy. The Borrower’s owner’s policy must include the same perils as the Cooperative Corporation’s master policy, cover master policy assessments levied on the Shareholder and carry a sufficient coverage amount to cover the per unit amount over the permissible 5% limit. See
Section 4703.2(c)
above for an example of how to calculate sufficient coverage to meet the 5% maximum deductible requirement for Cooperative Corporation Units.
Shareholders within a Cooperative Project of detached Cooperative Units can insure their units individually, provided that the requirements in
Section 4703.2(a)
are met and the Cooperative Corporation’s governing documents permit it.
