When you purchase a new home or apply to refinance the current home you have it is not uncommon for a lender to ask you for proof of mortgage insurance and homeowners’ insurance. Although the two sound like the same item, the two are very different items. Both types of insurance are meant to protect items related to your home, but they protect different things.
The Difference Between Mortgage Insurance and Home Insurance
The biggest difference between mortgage insurance and home insurance is who it protects. Homeowners insurance is protection for the borrower, while mortgage insurance is put in place to protect the lender.
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Homeowners’ insurance covers damage to the main structure built on the property and can cover other items on the property when you make sure they are included in the insurance plan. In the event that an emergency situation occurs such as a fire or major storm, insurance will cover the cost to restore the damaged item.
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Mortgage insurance or private mortgage insurance protects the mortgage lender if the borrower of the loan should end up unable to pay back the loan. It is a requirement of lenders for borrowers to purchase this insurance on mortgages where less than a 20% down payment is made. There are other scenarios where mortgage insurance may be required, but this is the most common. Some loans will require insurance held for the entire life of the loan and others allow homeowners to discontinue insurance when a specific amount of the loan is paid.
The Specifics of Private Mortgage Insurance
Private Mortgage Insurance or PMI protects the lender and gives them a guarantee that the risks they have concern with will be covered. PMI is required when you take out a conventional loan and make a down payment less than 20%. In a refinance, PMI is required when home equity is less than 20% of the value of the property.
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The Cost of PMI
The average cost for PMI per year is about .5% to 1% of the loan amount. For example, a $250,000 house could cost around $2,500 a year in insurance. This can add up to an extra $208 per month. PMI is most often paid for as part of the monthly mortgage payment. It can also be paid in the form of an up-front premium during closing. PMI terms for a loan can be found by reading the details of the loan estimate and closing disclosure.
Lenders may or may not give the borrower payment options for PMI, but a borrower can request some.
How Can You Avoid Paying PMI?
There are a few ways you can avoid a lender requesting you pay PMI
- Save up more money to make a larger down payment
- Ask the lender to pay the cost, this is known as a lender-paid mortgage insurance
- Do a piggyback mortgage where you take out more than one loan
- Find a lender with an incentive program that does not require a traditional 20% down
- VA loan
The Specifics of Homeowners’ Insurance
Homeowners’ insurance is meant to protect your home and cover the costs of large and devastating losses. A lender will not always require that a homeowner carry this insurance, but it is a smart idea for every homeowner to do so. The best approach to purchasing homeowner insurance is to not get the cheapest plan possible. Some homeowners go this route only to regret it when they find out their outbuilding was not covered or they will not be compensated for the cost of moving out of their home while it is repaired.
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Homeowners’ insurance covers your home structure if damaged, any personal belongings, liability from lawsuits that happen as a result of injuries at your home, etc. Covered events generally include explosions, fire, hail, lightning, theft, vandalism, windstorms, etc.
Most policies will not cover events like earthquakes, floods, arson, and sinkholes though extra insurance can be purchased to cover these things.
These two types of protection are often utilized and very important in purchasing homes, but are very different. They should both be factored in when thinking about the costs of your next home purchase.
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