Homeowners insurance protects property; mortgage insurance protects your lender
Homeowners insurance and mortgage insurance are both types of insurance that can add to the cost of owning property, and you’re likely to encounter both during the mortgage process. However, that’s where their similarity ends
Here’s the basic difference: Homeowners insurance protects your home and its contents, while mortgage insurance (also called private mortgage insurance, or PMI for short) protects your mortgage lender in case you can’t meet your mortgage payments.
- Homeowners insurance and mortgage insurance are very different types of insurance.
- Homeowners insurance protects your home, its contents, and you in case of lawsuits.
- Mortgage insurance, also called private mortgage insurance (PMI), protects your lender (the bank, for instance) if you can’t meet your mortgage payments.
- Most homeowners have homeowners insurance because it can make good financial sense to protect yourself from unexpected costs.
- You will be required to purchase PMI on top of your mortgage if you either make a down payment of less than 20% or take out a Federal Housing Administration (FHA) mortgage.
Homeowners Insurance vs. Mortgage Insurance
Though homeowners insurance and mortgage insurance sound similar, they are very different in reality. Here’s a brief description of each.
What Is Homeowners Insurance?
Homeowners insurance is a form of property insurance designed to protect your home and its contents from damage caused by unforeseen events. In addition, most homeowners insurance shields you from lawsuits if someone gets hurt on your property. It also insures your home and property from damage- or loss-related expenses. This insurance is best for someone wanting to protect their house and belongings.
A homeowners insurance policy may include coverage for your:
- Home’s structure
- Personal belongings
- Liability in lawsuits for injuries that you, your family members, and pets cause to other people
- Medical expenses if someone is hurt in your home
- Extra living expenses while your home is uninhabitable
There are limits, though. Standard homeowners insurance policies typically exclude damage caused by natural events like floods, mold, earth movements such as earthquakes and landslides, and sewer or drain backups or overflow.
What Is Mortgage Insurance?
Mortgage insurance, or private mortgage insurance (PMI), is very different. This is an insurance policy designed to protect the lender—a bank, for instance—in case you can’t meet your mortgage payments.
With PMI, the homeowner normally pays a percentage of their total mortgage cost each year. Then, if they are unable to make mortgage payments, the insurance company will pay the lender on their behalf. Adding PMI to your monthly bills can raise the cost of owning a house.
Do I Need Homeowners Insurance or Mortgage Insurance?
Which type of insurance you need depends on what kind of mortgage you have, the size of your down payment, and how close you are to paying off your mortgage.
Do I Need Homeowners Insurance?
Most homeowners have some kind of homeowners insurance. That’s partially because lenders often require homeowners to take out homeowners insurance to get a mortgage. Plenty of people have homeowners insurance for its own benefits, however, and continue to pay for it even after their mortgage finishes.
Homeowners insurance can make good financial sense because of the high replacement cost of homes and costly lawsuits. Monthly premiums can be much less than what you would ever have to pay to rebuild your home or replace all your possessions in the event of a covered disaster, or if you’re sued because a visitor got hurt.
Do I Need Mortgage Insurance?
The answer depends on your lender.
Borrowers are normally required to take out mortgage insurance when they supply a down payment of less than 20% of the home’s purchase price. This applies if you’re taking out a conventional loan, or if you’re refinancing your home and the equity is less than 20% of its value. For Federal Housing Administration (FHA) mortgage loans, a mortgage insurance premium (MIP)—the equivalent of PMI—is always required.
This is because lenders regard mortgages backed by less than a 20% down payment as risky, and they want protection in case you can’t meet your payments.
You can, however, cancel your PMI once you’ve paid off a good percentage of your mortgage. The rules in this regard vary, so check with your lender about their rules. In general, the earliest that you can cancel your PMI is when your principal balance falls to 80% of your home’s original value. This is defined by its contract sales price or appraised value at purchase (whichever is lower). You must have a history of on-time payments and be up to date with your bill when requesting cancellation.
FHA loans have their own rules. Depending on your loan-to-value (LTV) ratio when you took out your FHA loan, your loan terms may require you to maintain your MIP for 11 years, or for the length of your mortgage.
Are mortgage insurance and homeowners insurance interchangeable?
No. Homeowners insurance protects your home and its contents. Mortgage insurance (also called private mortgage insurance or PMI) protects your mortgage lender in case you can’t meet your mortgage payments.
Do you always need mortgage insurance?
Typically, borrowers making a down payment of less than 20% of the purchase price of the home will need to pay for mortgage insurance. Mortgage insurance also is typically required on Federal Housing Administration (FHA) and U.S. Department of Agriculture (USDA) loans.
How can I avoid PMI?
One way to avoid paying PMI is to make a down payment that is equal to 20% of the purchase price of the home. Don’t try and avoid buying PMI if you are obligated to. In that case, your lender can buy it for you and then charge you, which may be more expensive than getting it yourself.
The Bottom Line
You will encounter both homeowners insurance and mortgage insurance as you work through the mortgage process, but they are very different types of insurance.
Homeowners insurance protects your home, its contents, and you in case of lawsuits. Mortgage insurance, also called PMI, protects your lender (the bank, for instance) in the event that you can’t meet your mortgage payments.
Most homeowners have homeowners insurance, because it can make good financial sense to protect yourself from unexpected costs. You will be required to purchase PMI—on top of your mortgage—if your down payment is less than 20% or if you take out an FHA mortgage.
To read the full article, click here.