Mortgage Insurance vs Home Insurance
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When you're buying a home, your mortgage lender may require you to purchase homeowners insurance, mortgage insurance or both. These insurance policies are not the same, and it's important to understand the distinction between the two. Homeowners insurance protects the assets of both the borrower and the lender against qualifying events, such as fires or storms, while mortgage insurance protects the lender against borrower default.
Mortgage insurance and homeowners insurance: Key differences
A majority of homeowners finance their home purchases with mortgages. The fact that most homeowners have a mortgage leads people to believe that mortgage insurance is the same as homeowners insurance. In fact, the two types of insurance cover different things, and it's important you distinguish between the two in order to know what you're paying for.
Homeowners insurance | Mortgage insurance | |
|---|---|---|
| Covers … | The homeowner and indirectly the lender | Just the lender |
| Typically required for … | Borrowers financing their home purchases | Borrowers with down payments less than 20% of the home purchase price |
| Paid for through … | Monthly payments to lender or insurer | Monthly payments and/or a portion of closing costs of home purchase to lender or insurer |
Homeowners insurance coverage vs. mortgage insurance coverage
Homeowners insurance provides financial protection for your home and personal property.
By paying monthly premiums to an insurance company, you are essentially paying to protect the home and its contents from adverse events covered by the policy. Indirectly, homeowners insurance also provides financial protection for your lender. If your home is destroyed in a storm and you are unable to repay your debt, you may go into default on your mortgage loan.
Typically, homeowners insurance provides four types of coverage:
- Dwelling coverage: covers the structure of your home if damaged by hazards, such as wind or hail
- Personal property coverage: covers your home contents and personal belongings
- Liability coverage: covers you and your family members from liability lawsuits
- Additional living expenses coverage: covers living expenses if you're forced to temporarily live outside of your house
Your homeowners insurance policy will only extend each type of coverage up to certain limits. For example, the events, also called "perils," covered by your homeowners insurance will vary based on the type of policy you purchase.
Mortgage insurance, on the other hand, provides financial protection to a mortgage lender against the risk that a borrower will default on the mortgage.
Whereas homeowners insurance will protect both the borrower and, indirectly, the lender's assets, mortgage insurance solely protects the lender's asset: the repayment of the mortgage loan. In order to compensate for the extra risk engendered by the lender's higher exposure, lenders typically require mortgage insurance when a borrower makes a smaller down payment.
Who needs homeowners insurance vs. mortgage insurance?
Whether you need homeowners insurance, mortgage insurance or both depends on how you finance your property.
- Own your home outright: If you purchase your home or condo with cash, or if you ultimately pay off your mortgage, you can forgo homeowners insurance and mortgage insurance coverage. It's optional in these scenarios, but we strongly recommend buying a homeowners insurance policy regardless. Your home is likely one of your most significant financial assets, and its value and the value of your belongings could be entirely lost in a catastrophic event.
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Take out a mortgage: If you need to finance your new home, then your lender will almost certainly require homeowners insurance. The lender is doing this to protect its financial stake in your property. If you don't have insurance and can't file a claim to cover a loss, you might not be able to repay your lender. However, mortgage insurance is only typically required with FHA loans and with conventional mortgages where the down payment is less than 20% of the purchase price. The lender takes on more risk with smaller down payments and with certain types of loans, and mortgage insurance covers the lender if the borrower falls behind on payments.
How will you pay for homeowners insurance vs. mortgage insurance?
If you have a mortgage, you will generally pay homeowners insurance as part of your monthly mortgage payments. Mortgage lenders pay the premiums for you and incorporate the cost into your mortgage payments. The money will typically go into an escrow account before it's distributed to the insurance company.
Conversely, mortgage insurance payments can come in a variety of forms:
- Conventional loans: When the mortgage isn't guaranteed or insured by the federal government, a lender will typically require you to pay private mortgage insurance. PMI can be baked into your premium or paid in one lump sum at closing. You can ask your lender to cancel your PMI when you've reached a loan-to-value ratio of 80%.
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FHA loan: If your mortgage is insured by the Federal Housing Administration, you'll pay two forms of mortgage insurance: an upfront premium and a monthly payment (baked into the premium). FHA loans are suited for borrowers who want to make low down payments (starting at 3.5%) or have lower credit scores. The mortgage insurance covers the risks associated with this type of loan.