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, mortgage insurance is not the same as homeowners insurance. Both types of insurance protect different things. There are instances where one or both may be required, both payable by the borrower.

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 could pay you directly for the losses. Mortgage insurance, or private mortgage insurance (PMI), protects the mortgage lender against the borrower not paying back the private loan., especially in circumstances when you make a down payment less than the standard 20%. Some loan types require mortgage insurance for the life of the loan, while others allow you to cancel after a portion of the mortgage is repaid. PMI is typically required until enough of the mortgage has been paid off that you are no longer considered a high-risk borrower.

Homeowners Insurance Mortgage Insurance
Covers: The homeowner and the lender indirectly The lender
Does not cover: Arson and flooding are usually not covered. Sinkholes may or may not be covered depending on the provider. Earthquake coverage may be available as an endorsement. The homeowner
Required for: A borrower financing their home purchase A borrower making a smaller down payment, usually less than 20% of the home’s purchase price
Payment form: Borrower pays in monthly payments or escrow to an insurer or lender Borrower pays monthly payments and/or a portion of closing costs of home purchase to insurer set by lender
Average annual cost: *$1,477 for $250K in dwelling coverage 0.5% to 1% of the loan amount

Mortgage insurance

When you take out a loan 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 do not have the funds to pay 20% down to purchase their property. A lender could see this as a red flag. Someone who does not invest a sizable amount of their income into their property may not be as committed to stick with their mortgage payments for the long haul in the eyes of lenders. That’s where 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 home equity is less than 20 percent of the value of your home you will be asked to carry PMI, too.

How much does PMI cost?

The average annual cost of PMI is typically between 0.5% to 1% of the loan amount. A $250,000 mortgage could cost you as much as $2,500 per year or an extra $208 per month. According to the Consumer Financial Protection Bureau, PMI is most commonly paid as part of the monthly mortgage premium, but may be paid as an up-front premium during closing. You can find out your PMI terms by reviewing your loan estimate and closing disclosure.

PMI is arranged by the lender and provided by private insurance companies. A lender may or may not give you payment options, but you may 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 can I avoid paying PMI?

There are several ways to avoid paying PMI:

  • Save more: If you delay your home purchase and save a larger down payment, it could prevent you from having to pay PMI.
  • Ask the lender to pay: Some lenders will cover the cost, referred to as lender-paid mortgage insurance (LPMI). However, there is a tradeoff because you could have a higher interest rate on your mortgage if you go this route.
  • Get a piggyback mortgage: Instead of getting one mortgage, you could have two. This is most often done in an 80/10/10 split, with an 80% first mortgage, 10% second mortgage and a 10% down payment.
  • Find a lender with their own program: Some lenders offer low down payment options without PMI. This could be for first-time homebuyers, low-income buyers or people in certain professions, like doctors or teachers.
  • Use a Veterans Affairs (VA) loan: If you qualify for a loan through the Department of Veterans Affairs, you may be able to get a mortgage without a down payment and avoid paying PMI.

Is PMI tax deductible?

PMI was initially tax-deductible, but it was removed in 2017 when the Tax Cuts and Jobs Acts eliminated it. It was revived in 2019 with the Further Consolidated Appropriations Act, effective in 2020. To deduct PMI from your federal taxes, you have to itemize your deductions instead of taking the standard deduction.

How long do I have to pay for PMI?

If you use an FHA loan to purchase your home, you may be required to pay for the entire loan term. If you use a conventional loan, typically once your home reaches 20% in equity based on the appraised value or purchase price (whichever is lower), you can request PMI be removed. There are three ways to remove PMI from your mortgage:

  • Request cancellation: Once you fall below the 80% mark, you may request in writing to have your PMI canceled. You must be current on your payments, have a good payment history, and you may be required to provide proof the value of the home has not declined and there are no other mortgages.
  • Automatic termination: Once the principal balance reaches 78% of the original home value, the servicer must automatically terminate PMI.
  • Final termination: Once you have reached the halfway point of your mortgage’s amortization schedule, the lender must remove PMI. For example, the midpoint for a 30-year loan would be after 15 years of payments, regardless if you have reached 78% of the original 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 may have to choose between actual cash value versus replacement cost.

Cash value may be cheaper because you are paid a based on the value of your property at the time of loss, including depreciation. 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, on the other hand, does not factor in depreciation.

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 covered loss or damage from fire, certain hazardous weather events and 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 generally include damage or loss to your home or property because of:

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

Most policies do not cover other events like arson, earthquakes, floods and sinkholes, although you can often purchase an additional insurance rider or separate policy for some uncovered events. Flood insurance, for example, may be purchased through the National Flood Insurance Program (NFIP).

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 according to the terms of your policy. There is also coverage to help pay for 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 homeowners insurance primarily works to benefit you. Private mortgage insurance could cost you hundreds of dollars per month in premium payments to protect your lender so it is often not a preferred route for financing a home.

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. Additionally, because it may allow borrowers to start paying off a home sooner (compared to if you wait to save a full 20% down payment), having a PMI could lead you to become a homeowner sooner.

Methodology

Bankrate utilizes Quadrant Information Services to analyze 2021 rates for all ZIP codes and carriers in all 50 states and Washington, D.C. Quoted rates are based on 40-year-old male and female homeowners with a clean claim history, good credit and the following coverage limits:

  • Coverage A, Dwelling: $250,000
  • Coverage B, Other Structures: $25,000
  • Coverage C, Personal Property: $125,000
  • Coverage D, Loss of Use: $50,000
  • Coverage E, Liability: $300,000
  • Coverage F, Medical Payments: $1,000

The homeowners also have a $1,000 deductible and a separate wind and hail deductible (if required).

These are sample rates and should be used for comparative purposes only. Your quotes will differ.