Mortgage Insurance vs. Home Insurance: What’s the Difference?

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When you buy or refinance a home, your lender may ask you for proof of mortgage insurance and homeowners insurance. Although they sound related, they’re very different types of insurance. Read on to know the difference between mortgage insurance vs. home insurance and whether they’re required.

Mortgage insurance vs. home insurance

The key difference between mortgage insurance vs. home insurance is who it protects. Homeowners insurance mainly protects the borrower while mortgage insurance protects the lender.

Homeowners insurance protects your home’s structure and your property from most financially devastating losses like fires or storms. If your house is damaged, homeowners insurance will pay you directly for the losses.

Mortgage insurance protects the mortgage lender against the borrower not paying the loan. You pay for both types of insurance, but only one has any benefit to you.

Homeowners Insurance Mortgage Insurance
Covers: The homeowner and the lender indirectly The lender
Doesn’t cover: Arson, earthquakes, flooding and sinkholes The homeowner
Required for: A borrower financing their home purchase A borrower making a down payment of less than 20% of the home’s purchase price
Payment form: Borrower pays in monthly payments to an insurer or the lender Borrower pays monthly payments and/or a portion of closing costs of home purchase to insurer set by lender
Average annual cost: $1,192 0.5% to 1% of the loan amount

Mortgage Insurance

When you borrow to buy or refinance a home, a bank or lender takes a risk that you will make good on your mortgage.

Lenders look for low-risk borrowers with:

  • Good credit history
  • Steady employment
  • Low debt to income ratio
  • A 20% or higher down payment on the sale price of the property

Many borrowers check all the boxes but don’t have the funds to pay 20% down to purchase their property. A lender sees this as a red flag. Someone who doesn’t invest a sizable amount of their hard-earned cash into their property may not be as committed to stick with their mortgage payments for the long haul. That’s where Private Mortgage Insurance (PMI) comes in.

What is PMI?

Private Mortgage Insurance, or PMI, protects a bank or lender if you fail to pay your mortgage and walk away from the home. PMI gives a bank or lender a guarantee that its risk will be covered for lending you money.

PMI is usually required when you have a conventional home loan and make a down payment of less than 20 percent of the home’s purchase price. When refinancing, if your equity is less than 20 percent of the value of your home you will be asked to carry PMI, too.

PMI is arranged by the lender and provided by private insurance companies. A lender may or may not give you payment options but you can always request some. The most common ways to pay for PMI are:

  • A monthly premium added to your mortgage payment
  • A one-time up-front premium paid at closing
  • A combination of one up-front payment and monthly premiums

How much does PMI cost?

The average annual cost of PMI is between 0.5% to 1% of the loan amount. A $250,000 mortgage could cost you as much as $2500 per year or an extra $208.33 per month.

How can I avoid paying PMI?

To avoid having to pay PMI, pay at least 20% of the home’s purchase price as a down payment when you buy a home. Delaying a home’s purchase to save for a larger down payment can save you tens of thousands of dollars.

Is PMI tax deductible?

The 2017 Tax Cuts and Jobs Acts eliminated the tax deduction for PMI. Lawmakers are pushing for tax extensions but at this time, PMI is no longer tax deductible.

How long do I have to pay for PMI?

You’ll have to pay for private mortgage insurance until your home equity tops 20%. For example, if your remaining mortgage loan principal balance is $100,000 you can request your lender to suspend mandatory PMI payments once your home’s value is at least $120,000.

You’ll have to prove it though — most lenders will require you to draft a formal written request and pay for and provide an official appraisal as proof of your current home value.

Remember that private mortgage insurance protects the lender — not you — if you fall behind on your mortgage payments. If you don’t make your payments on time, your credit score will suffer and you may lose your house.

What is homeowners insurance?

Homeowners insurance protects your home’s structure and your property from most financially devastating losses like fires or storms. Without homeowners insurance, you’d have to pay to rebuild your home or replace all your belongings yourself.

Even if your lender doesn’t require you to have home insurance, it’s a good financial decision to have coverage. The premium is small compared to the cost of repairing or replacing a home and property in case of a fire or loss.

Consult with a trusted insurance adviser to buy the proper amount of coverage. Homeowners insurance policies come with set limits. You’ll have to choose between cash value versus replacement cost.

Cash value may be cheaper because you are paid a preset amount for your property but the amount may not be enough to replace your damaged structure and property with a new item of similar quality in the future. Replacement value accounts for these cost increases due to inflation and other factors.

What does homeowners insurance cover?

Each homeowners insurance policy is different. A standard homeowners insurance policy covers the following main categories in case of a loss or damage from fire, bad weather or theft:

  • Your home’s structure if damaged
  • Your personal property/belongings
  • Personal liability from lawsuits due to accidents and/or injuries that happen at your home
  • Living expenses while you’re unable to live in your home

Covered events include damage or loss to your home or property because of:

  • Explosions
  • Fire
  • Hail
  • Lightning strikes
  • Theft
  • Vandalism
  • Windstorms

Most policies don’t cover other events like arson, earthquakes, floods and sinkholes although you can purchase an additional insurance rider for uncovered events.

Why does my mortgage lender require me to have home insurance?

A lender wants to protect their investment. They want you to be able to repair your home so you can continue living there and making mortgage payments or repay the balance you owe if your home is a total loss.

What does homeowners insurance pay for if my home is damaged due to a fire?

Your standard homeowners insurance will pay for the cost of repairing the fire damage to your property, structure and contents. They will also pay additional living expenses if you need to stay somewhere else while the repairs are made.

The Bottom Line

Although private mortgage insurance and homeowners insurance are both related to your home, only one has any real benefit to you. Private mortgage insurance could cost you hundreds of dollars per month in premium payments to protect your lender and should be avoided if possible.

Homeowners insurance spreads out your financial risk if you suffer major damage or a complete loss of your home and property. It covers the cost of repairing or replacing your home and property by paying you directly and is an expense worth paying for.