The difference between mortgage and homeowners insurance lies in their purposes: the former protects the lender, and the latter protects the homeowner's property. Mortgage insurance is typically required for those who have a smaller down payment of less than 20% on their home, while homeowners insurance provides coverage for sudden damages to your home and personal possessions.
If you're looking to buy or own a home, it's key to familiarize yourself with these types of insurance, as they can impact mortgage terms, monthly payments and the level of protection against potential losses. By understanding these distinctions, you can ensure you’re well-prepared to select the right coverage, meet lender criteria and protect your home in the long run.
What's the Difference Between Mortgage and Homeowners Insurance?
While homeowners insurance provides coverage for your home and its contents against unexpected damages, mortgage insurance ensures the lender's financial security if you fail to meet your mortgage obligations. Both types of insurance are paid by the homeowner or borrower and contribute to the overall financial structure of buying and owning a home. Understanding the differences is essential for anyone entering the housing market.
Who needs it?
What does it cover?
Home's structure, personal belongings, liability in lawsuits, medical expenses
Lenders finances if the borrower can't meet mortgage payments
What does it not cover?
Floods, mold, earthquakes, landslides, sewer backups
Is it required?
Required by mortgage lenders
Required for down payments less than 20% or FHA mortgages
Who pays for it?
How do you pay?
Premiums are paid directly or through an escrow
Premiums are paid directly or through an escrow
How much does it cost?
Average $1,979 per year for $250,000 in dwelling coverage
Depends on loan amount, credit score and loan-to-value (LTV) ratio
What Is Mortgage Insurance?
Mortgage insurance, also known as private mortgage insurance (PMI), is a type of insurance policy designed to protect the lender in case the borrower cannot repay the mortgage. It's a common requirement for those who make a down payment of less than 20% on their home purchase.
Unlike homeowners insurance, which covers the house and its contents, mortgage insurance is exclusively for lenders. It ensures that the lender can recover some of the losses if the borrower defaults on the loan. This type of insurance is a standard part of the mortgage process, especially for conventional and FHA loans.
Is Mortgage Insurance Required?
Mortgage insurance is typically a requirement if your down payment is less than 20% of the home's purchase price, but this can vary depending on your lender. For FHA loans, on the other hand, a mortgage insurance premium (MIP) is always required. While mortgage insurance is an additional expense, it allows many buyers to enter the housing market who might otherwise be considered too high-risk.
How Long Do You Need to Pay Mortgage Insurance?
It’s worth noting that mortgage insurance is not a requirement for the life of the loan. Once you’ve reached 20% equity in your property based on the purchase price or appraised value (whichever is lesser), you can have your PMI removed. Canceling PMI can be done in a variety of ways:
- Cancellation by Request: Contact your lender to cancel PMI once you've achieved 20% equity in your property.
- Termination by Law: PMI must be automatically terminated by the lender when your loan balance falls to 78% of the home's original value.
- Through Refinancing: Refinancing to a new loan without PMI may be an option if you have owned your home for long enough and meet your lender’s requirements.
- Mandatory Final Termination: Lenders are obligated to terminate PMI at the midpoint of your loan term if not canceled earlier.
Tips to Avoid Needing Mortgage Insurance
While PMI is essential for those making a down payment of less than 20%, there are strategies to avoid needing PMI. From saving for a larger down payment to exploring lender-specific mortgage insurance programs, here are some ways to avoid paying for mortgage insurance:
Save More for a Larger Down Payment
A down payment of 20% or more typically eliminates the requirement for mortgage insurance, reducing overall borrowing costs. By delaying the home purchase and saving more for a larger down payment, you can avoid PMI.
Ask the Lender to Pay (Lender-Paid Mortgage Insurance)
Some lenders may offer to cover the cost of your mortgage insurance, known as lender-paid mortgage insurance (LPMI). While this eliminates the PMI cost, it may result in a higher interest rate on your mortgage.
Get a Piggyback Mortgage
A piggyback mortgage="_blank"> is a strategy that combines a main mortgage with a second one, allowing borrowers to finance up to 90% of a home's value without private mortgage insurance. By opting for a 10% down payment, an 80% main mortgage and a 10% piggyback second mortgage, potential homeowners can bypass the need for mortgage insurance. Though this approach may come with a higher interest rate for the second mortgage, it offers a viable alternative for potential homeowners seeking unique financing solutions.
Use a Veterans Affairs (VA) Loan
If you qualify for a loan through the Department of Veterans Affairs, you may be able to secure a mortgage without a down payment and avoid PMI. VA loans are designed to support veterans and eligible service members, providing a PMI-free home financing option.
Refinance Your Existing Mortgage
If you've built enough equity in your home, you may be able to refinance your existing mortgage into a new loan to remove PMI. Refinancing can be a strategic way to eliminate mortgage insurance and get better terms if you meet the lender's eligibility requirements.
What Is Home Insurance?
Homeowners insurance is a form of financial protection for your home, one of your most valuable assets, against unforeseen events. It covers the cost of repairing or rebuilding your home following damaging events such as fire or theft. Additionally, it extends protection to personal belongings and medical expenses if an injury occurs on your premises. Homeowners insurance provides peace of mind, giving you a robust defense against potential financial burdens.
What Does Home Insurance Cover?
Understanding what home insurance covers is key to making informed decisions that align with your unique needs and circumstances.
- Dwelling Coverage: Dwelling coverage covers the cost to repair or rebuild the physical structure of your home if it's damaged by a covered peril. For example, if a fire destroys your kitchen, dwelling coverage would pay for the necessary repairs or rebuilding.
- Personal Property Coverage: Personal property coverage offers coverage for the personal belongings inside your home, such as appliances, clothing and electronics. If a storm damages your television, personal property coverage alleviates the financial burden of replacement.
- Liability Protection: Liability coverage protects you if someone is injured on your property and you are found legally responsible. For instance, if a guest slips on your icy driveway and breaks their arm, liability protection would cover their medical expenses.
- Medical Payments to Others: This covers medical expenses for guests who are injured on your property, regardless of who is at fault. If a friend falls and hurts themselves while walking up your front steps, this coverage would pay for their medical treatment.
- Additional Living Expenses (ALE): ALE covers the costs of living away from home if it becomes uninhabitable due to a covered peril. For example, if a storm damages your roof and you need to stay in a hotel while it's being repaired, ALE would cover those expenses.
- Other Structures: Homeowners insurance also extends to detached structures on your property, like a garage or fence. If a fallen tree damages your garden shed, this coverage helps with repair costs.
- High-Value Items: Specific coverage for valuable items like antiques or jewelry is part of comprehensive homeowners insurance but at an additional cost. For instance, if you have a cherished heirloom ring and it gets stolen, this coverage will provide financial compensation.
- Optional Endorsements and Riders: You can get optional coverages for specific needs, such as flood or earthquake insurance. For example, if you live in an area prone to earthquakes, you might add an earthquake endorsement to ensure coverage for potential quake-related damages.
Is Home Insurance Required for a Mortgage?
Lenders will generally require you to secure home insurance before funding the loan, as it safeguards their financial interest in the property. Since the house acts as collateral for a mortgage, it's in the lender's best interest to ensure that it stays in good condition in case they ever need to sell it to recoup their losses.
Even after you've repaid the mortgage, maintaining homeowners insurance is wise to prevent financial ruin in the event of a disaster.
Is Home Insurance Included in the Mortgage?
Home insurance is not included in the mortgage, but it is often paid through an escrow account set up by the mortgage lender. An escrow account acts as a secure intermediary, holding funds for mortgage-related expenses such as home insurance and property taxes. A portion of your mortgage payment is set aside in this account to cover insurance premiums, and when it's time to pay, the escrow agent releases the funds to the insurance provider.
This setup ensures timely payments and uninterrupted protection for your home. However, it's worth noting that escrow accounts may collect more funds than necessary as a buffer, which can be challenging for budget-conscious homeowners.
Mortgage insurance and homeowners insurance play different roles in protecting your investment. Our answers to some of the most frequently asked questions can help reduce the confusion surrounding these two types of insurance.
About Mark Fitzpatrick