Homeowners Insurance vs. Mortgage Insurance

Homeowners insurance protects property; mortgage insurance protects your lender

Fact checked by Yarilet PerezReviewed by Eric EstevezFact checked by Yarilet PerezReviewed by Eric Estevez

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.

Homeowners insurance protects your home and its contents, while mortgage insurance, also called private mortgage insurance (PMI), protects your mortgage lender in case you default on your mortgage payments.

Key Takeaways

• Homeowners insurance and mortgage insurance are very different types of insurance.
• Homeowners insurance protects your home, its contents, and you from liability in case of lawsuits.
• Homeowners insurance makes good financial sense because it protects you from unexpected costs. 
• Mortgage insurance, or private mortgage insurance (PMI), protects your lender or bank if you fail to make your mortgage payments.
• Private mortgage insurance (PMI) is required with a mortgage loan if your down payment is less than 20%.

Homeowners Insurance vs. Mortgage Insurance

Though homeowners insurance and mortgage insurance sound similar, the two have distinct differences.

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.

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 

However, standard homeowners insurance policies come with limits, typically excluding 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. Mortgage insurance is designed to protect the lender or bank in case you fail to make 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.

Important

Mortgage insurance provides protection for the lender, not the homeowner.

Key Differences

The key differences between these two types of insurance can be summarized as follows:

Do I Need Homeowners Insurance or Mortgage Insurance?

Which type of insurance you need depends on the type of mortgage loan, 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 since mortgage lenders often require homeowners insurance to get approved for a mortgage. Lenders want to be protected in case your home is irreparably damaged or destroyed. The mortgagee clause accomplishes this by requiring the insurance company to pay the lender.

However, many people maintain their homeowners insurance for its benefits long after their mortgage loan has been paid off.

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 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?

Depending on your lender, borrowers are typically required to take out mortgage insurance when they supply a down payment of less than 20% of the home’s purchase price. PMI applies if you’re taking out a conventional loan or 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 requirement 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. 

However, you can usually cancel your PMI once you’ve paid off enough of the loan that it reaches 80% of your home’s original value. This valuation 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 payments 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 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 is also typically required for Federal Housing Administration (FHA) and U.S. Department of Agriculture (USDA) loans.

How Can I Avoid PMI?

One way to avoid paying PMI is by making a down payment equal to 20% of the home’s purchase price. Don’t try to avoid buying PMI if you are obligated to do so because your lender can buy it for you and charge you, which may be more expensive than buying it yourself.

The Bottom Line

As you work through the mortgage process, you’ll likely encounter both homeowners insurance and mortgage insurance, which are different from each other. 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.

Homeowners insurance can make good financial sense since it protects you 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-insured mortgage.

Read the original article on Investopedia.