Find Cheap Homeowners Insurance Quotes in Your Area
When you're buying a home, your mortgage lender may require you to also purchase homeowners insurance, mortgage insurance or both. Although many people finance their home purchases with mortgages, mortgage insurance is not the same as homeowners insurance, 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.
|Covers …||The homeowner and indirectly the lender||Just the lender|
|Typically required for …||Borrowers financing their home purchases||Borrowers making 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 members from liability lawsuits
- Additional living expenses coverage: ‘if your home is unlivable, this covers living expenses associated with temporarily residing out 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 to be purchased by borrowers who make smaller down payments.
Who Needs Homeowners Insurance vs. Mortgage Insurance?
Whether you will be required to obtain homeowners insurance, mortgage insurance or both will depend on how you finance the purchase of your property. 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. Although it's optional in these scenarios, we strongly recommend that you purchase 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 catastrophic event.
If you plan to obtain a mortgage to finance the purchase of your home or condo, your lender will almost certainly require you to purchase homeowners insurance. The lender is doing this to protect the financial stake it is holding in your property. If you don't have insurance and can't file a claim to cover your loss of your house or your belongings in a fire, it's possible you will be unable to repay your lender.
Though obtaining a mortgage will generally require purchasing homeowners insurance, it will not necessarily require mortgage insurance. Mortgage insurance will typically only be required by your lender if you make down payment on your home lower than 20 percent of its purchase price. For instance, if the purchase price of your prospective home is $200,000 and you make a down payment of $30,000 (15 percent), you will likely be required to pay mortgage insurance premiums. A smaller down payment from you results in higher exposure for your lender, and mortgage insurance will cover the lender in the event you cannot repay your loan. Depending on the type of loan, you may be required to pay different types of mortgage insurance; the most common variants being private mortgage insurance (PMI) or Federal Housing Administration (FHA) loan mortgage insurance.
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 will pay the premiums for you and incorporate that cost into your mortgage payments. The money will typically go into an escrow account, along with your payments for property taxes, before being distributed to the insurance company.
Conversely, mortgage insurance payments can come in a variety of forms. For a conventional mortgage, one not guaranteed or insured by the federal government, a lender will typically require you to pay PMI. This PMI payment can come in the form of higher monthly premiums, paying higher monthly interest payments as a substitute for those premiums or a large upfront payment.
If your mortgage is a FHA loan, you will be required to pay mortgage insurance in the form of an upfront premium as well as monthly premium payments. FHA loans are made by private lenders but are regulated and insured by the FHA, a government agency. These mortgages are suited for lower-income borrowers because they permit lower credit scores and down payments as low as 3.5 percent of the purchase price of the home. To cover the higher risk associated with these loans, FHA borrowers are required to pay both an upfront premium cost at closing of the home purchase and monthly premiums.
Although we recommend paying homeowners insurance for the entirety of your homeownership, mortgage insurance does not have to be, and shouldn't be, paid indefinitely. If you're a borrower paying monthly PMI premiums, you can request to cancel your premium payments when you have reached a loan-to-value ratio of 80 percent. In other words, the requirement to pay mortgage insurance can generally be waived once your equity reaches 20 percent of the appraised value of the property.
In most cases, ending your mortgage insurance payments for FHA loans requires you to refinance your FHA loan into a conventional mortgage. Exceptions to this rule may apply if you received your FHA loan before June 2013 or if you put a down payment on your home greater than 10 percent of the purchase price.