Mortgage Insurance vs Homeowners Insurance: Homeowners insurance protects your property, whereas mortgage insurance protects your lender.
Homeowners insurance and mortgage insurance are both types of insurance that can increase the cost of owning property, and you’re likely to encounter both during the mortgage process. However, that is where their similarities end.
The basic distinction is that homeowners insurance protects your home and its contents, whereas mortgage insurance (also known as private mortgage insurance, or PMI for short) protects your mortgage lender if you fail to make your mortgage payments.
KEY TAKEAWAYS
- Homeowners insurance and mortgage insurance are two very different types of insurance.
- Homeowners insurance protects your home, its contents, and you from lawsuits.
- Mortgage insurance, also known as private mortgage insurance (PMI), protects your lender (for example, the bank) if you are unable to make your mortgage payments.
- Most homeowners have homeowners insurance because it can make good financial sense to protect yourself from unexpected costs.
- If you make a down payment of less than 20% or use a Federal Housing Administration (FHA) loan, you will be required to purchase PMI on top of your mortgage.
Homeowners Insurance vs. Mortgage Insurance
Though homeowners insurance and mortgage insurance appear to be the same thing, they are not. Here’s a quick rundown of each.
What Is Homeowners Insurance?
Homeowners insurance is a type of property insurance that protects your home and its contents from damage caused by unforeseen events. Furthermore, most homeowner’s insurance protects you from lawsuits if someone is injured on your property. It also protects your home and property from damage or loss-related expenses. This insurance is ideal for anyone looking to protect their home and belongings.
A homeowners insurance policy may include coverage for your:
- The house’s structure
- Personal belongings
- Liability in lawsuits for injuries caused by you, your family, and your pets to others
- Medical expenses if someone is injured in your home
- Extra living expenses while your home is uninhabitable
There are, however, constraints. Natural events such as floods, mould, earth movements such as earthquakes and landslides, and sewer or drain backups or overflows are typically excluded from standard homeowners insurance policies.
What Is Mortgage Insurance?
Mortgage insurance, also known as private mortgage insurance (PMI), is very different. This is an insurance policy designed to protect the lender—say, a bank—if you fail to make your mortgage payments.
With PMI, the homeowner typically pays a percentage of their total mortgage cost each year. 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 home.
Mortgage insurance protects the lender, not the homeowner.
Significant Differences
The primary distinctions between these two types of insurance are as follows:
| Homeowners Insurance | Mortgage Insurance | |
| Covers | Homeowner directly and mortgage lender indirectly | Mortgage lender |
| Does not cover | A standard homeowners insurance policy typically excludes coverage for property damage caused by losses such as arson, flooding, sinkholes, mudslides, and earthquakes | Homeowner |
| Required for | A borrower financing their home purchase | A borrower making a lower down payment, usually less than 20% of the home’s purchase price |
| Payment form | Generally, the policyholder pays the premium directly to the insurance company or to the mortgage company, which then pays the homeowners insurance from the escrow account managed by the lender | Borrower pays monthly payments and/or a portion of closing costs of a home purchase to the mortgage insurer set by the lender |
| Average annual cost | Nationwide average of $1,251 per year | The cost depends on three factors: the loan amount, your credit score, and your loan-to-value (LTV) ratio. For property worth $250,000, the cost ranges from $1,091 to $1,747 per month. |
Data from the National Association of Insurance Commissioners, “NAIC Releases Report on Homeowners Insurance,” and the Urban Institute, “Housing Finance at a Glance.”
Do I Need Homeowners or Mortgage Insurance?
The type of insurance you require is determined by the type 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 form of homeowners insurance. This is partly because lenders frequently require homeowners to obtain homeowners insurance in order to obtain a mortgage. However, many people have homeowners insurance for its own benefits and continue to pay for it even after their mortgage is paid off.
Due to the high replacement cost of homes and the high cost of lawsuits, homeowners insurance can make good financial sense. Monthly premiums may be much less than what you would have to pay to rebuild your home or replace all of your possessions in the event of a covered disaster, or if you are sued because a visitor was injured.
Do I Need Mortgage Insurance?
The answer is dependent on your lender.
Borrowers who put down less than 20% on a home are typically required to purchase mortgage insurance. This is true if you are taking out a conventional loan or refinancing your home and your equity is less than 20% of its value. A mortgage insurance premium (MIP)—the equivalent of PMI—is always required for FHA mortgage loans.
This is because lenders consider mortgages with less than a 20% down payment to be risky, and they want protection in case you can’t make your payments.
You can, however, cancel your PMI once you’ve paid off a significant portion of your mortgage. The rules in this regard vary, so check with your lender to learn more. In general, you can cancel your PMI when your principal balance falls to 80% of the original value of your home. This is defined by its contract sales price or appraised value at the time of purchase (whichever is lower). When requesting cancellation, you must have a history of on-time payments and be current on your bill.
FHA loans have their own set of 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 life of your mortgage.
Are mortgage insurance and homeowners insurance interchangeable?
No. Homeowners insurance protects your home and its contents. Mortgage insurance (also known as private mortgage insurance or PMI) protects your mortgage lender if you fail to make your mortgage payments.
Do you always need mortgage insurance?
Borrowers who put down less than 20% on a home typically must pay mortgage insurance. Mortgage insurance is also typically required on FHA and USDA loans.
How can I avoid PMI?
Making a 20% down payment on a home is one way to avoid paying PMI. If you are required to purchase PMI, do not try to avoid doing so. In that case, your lender can buy it for you and charge you, which may be more expensive than getting it yourself.
The Bottom Line
You will come across both homeowners insurance and mortgage insurance as you go through the mortgage process, but they are very different types of insurance.
Homeowners insurance protects your home, its contents, and you from lawsuits. Mortgage insurance, also known as PMI, protects your lender (for example, the bank) in the event that you are unable to make your mortgage payments.
Most homeowners have homeowners insurance because it can make good financial sense to protect yourself from unexpected costs. If your down payment is less than 20% or you take out an FHA loan, you will be required to purchase PMI on top of your mortgage.
