Introduction
Purchasing a home is one of life’s most important financial milestones. As you navigate this process, you will inevitably be faced with a lot of new terms, responsibilities, and insurance. The two insurance types often confused for one another are homeowners insurance and mortgage insurance.
They share a similar name but have very different functions: one protects you – the homeowner – while the other protects your lender. Understanding the distinctions will empower you to make informed financial decisions, as well as keep surprises from occurring at the closing table, and avoid being under or over-insured.
Let’s unpack it further.
What Is Homeowners Insurance?
Homeowners insurance is coverage for you, the owner of the property, for potential risks that can cause a loss or damage. Most lenders actually require you to have homeowners’ insurance before they will consider offering you a mortgage because they want to protect you and their collateral (the house). Homeowners’ insurance typically covers:
The dwellings: Damages caused by fire, storms, theft, or vandalism.
Personal property: You and your family, such as furniture, electronics, and valuables inside your home.
Liability: In the event that someone gets hurt on your property and sues you.
Additional living expenses: If you cannot live in your home, temporarily, after a covered disaster, your insurance will help pay for hotel stays or rentals.
For example, if a kitchen fire damaged part of your home, your insurance would reimburse you for repairs. Or, if a guest slips on icy stairs and requires medical treatment, your liability coverage would protect you. Overall, homeowners’ insurance covers you and your belongings.
What Is Mortgage Insurance?
Mortgage insurance, unlike homeowner insurance which protects you, protects your lender.
When you purchase a home, lenders want to be sure they’ll get their money back in the event of a default on your loan. If you make a down payment of less than 20%, the majority of lenders are likely to request mortgage insurance for their protection.
Types of mortgage insurance:
Private Mortgage Insurance (PMI): For a conventional loan. You pay a monthly premium that normally costs between 0.5% – 1.5% of the loan amount on an annual basis.
FHA Mortgage Insurance Premium (MIP): For government-backed FHA loans which have both upfront payment and annual payments.
VA and USDA loan guarantees: There may also be a funding fee instead of mortgage insurance.
Mortgage insurance does not protect the home you purchased or its contents. Mortgage insurance pays the lender back for any losses incurred in the event that you stopped payment on your mortgage.
So, in sum, mortgage insurance protects your lender, not you.
Is it Possible to Avoid Mortgage Insurance?
Yes, this is possible in various scenarios. Here are several options to eliminate mortgage insurance payments:
1. Pay a larger down payment: By contributing at least 20% of the home price as a payment, you may not have mortgage insurance at all.
2. Select a different loan program: VA loans (benefits for veterans or service members) have no mortgage insurance forgiveness.
3. Refinance: Once your values have appreciated and you have at least 20% equity, you can refinance into a conventional loan that won’t require mortgage insurance.
4. Ask for it to be cancelled: By generally the time your loan gets to a loan-to-value ratio of 80% you can ask the lender to remove any existing mortgage insurance on conventional loans.
Reasons Why You May Need Both Insurances At Times
Just because you may have mortgage insurance doesn’t mean you’re protected against fire, theft, or liability issues. Mortgage insurance only protects the lender’s financial interest in the transaction, not your home or personal exposure.
Homeowners’ insurance relates specifically to covering your risks as a property owner, but is not related to your lender’s risk of default. Nevertheless, more often than not both types of insurance may exist side by side, especially if you buy with a low down payment.
View it in this way:
- Homeowners insurance = Your safeguard
- Mortgage insurance = A safeguard for your lender
Conclusion
When purchasing real estate, insurance can feel intrusive or excessive. However, once you understand the distinctions beween homeowners’ insurance and mortgage insurance, it will most likely ease the process.
- Homeowners’ insurance will offer you and the property protection for the risks from fire, theft, liability, and disaster.
- Mortgage insurance will provide insurance to the lender in the chance that you will not make your mortgage payments.
Although both types of policies are often required in the experience of buying a home, only one protects your investment. To ensure you include comparably sized items in your budget when you purchase your new home, ensure that you include both. And, keep in mind, you will eventually drop your mortgage insurance.
At the end of the day, real estate is mostly not about buying a property for your future – it is about protecting that property. The correct insurance, when purchased, means your home will remain the safe, secure, and valuable asset that it has for many years.
