“Hazard insurance” is essentially property damage insurance for a home in the event of things like vandalism, a fire, or a wind storm.

It is important to note that hazard insurance does not necessarily include liability coverage. Typically a homeowner’s insurance policy includes both.

Banks and mortgage lenders will not provide financing unless hazard insurance is purchased to protect the property. Lenders simply need to ensure that if the home is damaged, burned to the ground for example, an insurance company will cover the loss, repairing the home or rebuilding it if necessary.

Imagine if you purchased a home by borrowing $200,000 from your local bank.  What would happen one year later if the house burnt down and you didn’t have hazard insurance? You would still owe most of the loan balance on the property and have nothing to show for it.

Even the most morally conscious person would struggle with the idea of paying back the rest of the money, while also paying rent or another mortgage on a new property.

Hazard insurance guarantees the home is rebuilt or repaired, which statistically helps ensure the associated loan is paid off and the bank doesn’t get stuck footing the bill for a crispy home.

Hazard insurance offers a unique form of payments called impounding. Your lender will collect a portion of your yearly premium from you monthly as you make your mortgage payment, and then pay your premium for you when it’s due.

While this may be convenient, I recommend that you pay your own insurance premium in full annually, or in installment payments if that’s more comfortable for you.

Ultimately, if you impound insurance (and taxes), you’re allowing the bank to collect interest on your money throughout the year. That’s interest you could collect if you kept the money in a account for yourself.