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Earthquake Insurance in California
When the water started draining from New Orleans in 2005, we learned that most homeowners in New Orleans did not have flood insurance because they were located in supposedly “low-risk” areas. Over 60% of homeowners must rely on their savings and limited federal aid to rebuild New Orleans—at an incalculable cost to homeowners and taxpayers.
Could such a disaster, especially an uninsured one, happen in California? Fewer than 15% of California homeowners currently carry earthquake insurance because of its high cost, the “can’t happen to me or my house” factor, and mortgage lenders who don’t require coverage. The next big earthquake will lead to billions in uninsured damage – but is earthquake insurance really worth the high price?
How did we get here?
The state of California requires all homeowner’s insurers to at least offer earthquake coverage (albeit at a high cost). It was widely available until 1994, but due to the extensive damage caused by the Northridge earthquake, 97% of homeowner’s insurance providers pulled out of the state of California. In response, the California legislature created the California Earthquake Authority to provide earthquake insurance.
What is the California Earthquake Authority and how does it work?
The California Earthquake Bureau underwrites two-thirds of California earthquake policies sold through their member providers, such as Allstate and State Farm. The homeowner purchases the policy through their regular insurance agent, but the policy is actually a CEA policy.
CEA currently has about $7.2 billion in claims, which it says is enough to cover foreseeable damages (in 1989, Loma Prieta had a total loss of $6 billion). If claims are greater than $7.2 billion, each claimant would be paid a pro rata share of their losses—unlike a typical insurance company that promises to pay actual losses under an insurance policy. The State of California cannot help pay claims from general funds.
Policies also have high deductibles – typically 15% of the home’s value. In other words, your home must be damaged by more than 15% of its value before insurance will pay. So, this insurance isn’t for cracks in your driveway – it’s for significant structural damage to your home. The policy also pays for limited contents (from $5,000) and loss of use (from $1,500).
Why is earthquake insurance so expensive?
Insurance policy premiums are calculated based on probabilities—the likelihood that a house like yours will catch fire in a neighborhood like yours or a driver like you will get into an accident. Based on data from millions of homes, these probabilities can be calculated with reasonable accuracy. But no one can reliably predict the likelihood of an earthquake strong enough to damage your home.
And as you can imagine, damage from an earthquake, flood, or hurricane is widespread, potentially covering thousands of square miles—instead of one or a few dozen homes, as in a fire. As such, the insurer would have to pay either zero losses or billions of dollars in losses—too many differences to reasonably plan for or accurately estimate.
Are we really in danger here in San Jose?
According to the USGS, there is a 62% chance that the Bay Area will experience a magnitude 6.7 or greater earthquake (like the Northridge earthquake) in the next 30 years. In my zip code (San Jose 95126), the USGS calculates an 80% chance of a 6.0 earthquake and a 20% chance of a 7.0 in the next 30 years. Whether you consider this a high risk depends on your risk tolerance for earthquakes – I think the risk of a moderate earthquake in the next 30 years is high and the risk of a major earthquake is somewhat low.
But like any real estate matter, it’s all local. The actual location of your home greatly affects your risk – bedrock, reclaimed land from the bay, soil type, nearby streams, actual distance from the epicenter can all affect potential damage.
But of course many earthquakes happen where the USGS wasn’t even aware of the fault line – and we never know when or where it will happen until it happens.
Should I Get Earthquake Insurance?
The following must be taken into account:
- Could you use your savings and investments to pay for your home remodeling?
- Can you afford to pay high insurance costs indefinitely?
- Could you pay to refinance your current mortgage and new loan?
- Can you mitigate your potential damages by, for example, screwing the roof walls and walls to the foundation?
- What is your tolerance for earthquake risk?
- What are the risks of building your current home (type, age, foundation)?
- What are the risks in your specific location (soil type, distance to known faults)?
Is the cost worth it?
Let’s say you have a home that would cost $250,000 to remodel, you own the home for the next 30 years, and your earthquake payments are $1,200 per year. Over the next 30 years, that would total $36,000 in premiums (assuming your premiums don’t increase to simplify the calculations).
Instead of buying insurance, you invest the premiums in a diversified mutual fund. At an 8% annual return, you’d have $135,000 (pre-tax) in year 30.* But of course, you’ll only have that total in year 30, not year one—meaning if there’s an earthquake tomorrow, you won’t. no money.
Deductibles are another big turn off for many homeowners. Insurance only pays for major structural damage, not broken dishes or cracked driveways – meaning you’re less likely to use it. But remember, you don’t have to come up with the money for the deductible — you can either skip those repair or remodeling costs or apply for an SBA loan to pay the deductible (assuming it’s a federal disaster). area is declared).
Why not just get a federal bailout or “walk away” and let the bank own the property?
The federal government would likely provide access to SBA loans if an area is declared a federal disaster area (no small business required). However, the SBA’s maximum $200,000 loan may not be enough to build your home—it’s a loan you’ll have to pay back (in addition to your current mortgage).
Once you’ve refinanced your mortgage, you have a recourse mortgage – meaning that not only can the bank foreclose on the property if you default, but the bank can also come after your personal assets and future income if you default. . So you can’t just walk away, especially if you have a good income and some personal assets. The bank can help by postponing the payments for a few months, but the loan still has to be repaid.
Our home has earthquake insurance. Our home wasn’t built in the 1906 earthquake (so who knows if it’ll hold up), it’s 75+ years old and not bolted to the foundation, and we have a refinanced mortgage. For my family, the insurance premiums are worth the peace of mind in the event of a major earthquake disaster. That’s what insurance is for – “you never know”.
*calculations ignore inflation
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