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If you’re thinking about buying a home, it’s important to understand the difference between mortgage insurance and homeowners insurance. Only one benefits you as the homeowner, while the other benefits the lender.
Here’s what you need to know about mortgage insurance and homeowners insurance:
- Mortgage insurance vs. homeowners insurance
- Is homeowners insurance included in my mortgage payments?
Mortgage insurance vs. homeowners insurance
The key difference between mortgage insurance and homeowners insurance is who each protects:
- Homeowners insurance: This directly protects you, the homeowner. It covers damage to your home and its contents, and it can also help pay for legal expenses if you’re held liable for someone’s injuries or property damage.
- Mortgage insurance: This directly protects your mortgage lender or investor (such as Fannie Mae or Freddie Mac); it doesn’t protect you at all. However, it can indirectly benefit you by allowing you to purchase a home with less than 20% down.
Mortgage insurance reimburses your mortgage lender or investor for a percentage of what you borrowed if you can’t repay your home loan.
The reimbursement amount is based on the size of your down payment and loan term, as well as the lender’s total loss: That is, how much you owed at the time of foreclosure plus the lender’s foreclosure costs.
Here are the two main types of mortgage insurance:
- Private mortgage insurance (PMI): Your lender may require private mortgage insurance if you’re putting down less than 20%, and it’s available for conventional, jumbo, and other home loans that aren’t insured by the government. You can request to cancel PMI on your primary residence once you reach 20% equity in your home, and your loan servicer must cancel it once you have 22% equity as long as you’re current on the loan.
- Mortgage insurance premium (MIP): With an FHA loan, your mortgage insurance premiums go to the Federal Housing Administration to protect taxpayers from losing money if you default on your mortgage. You’ll pay FHA mortgage insurance premiums no matter how much you put down. However, if you put down less than 10%, you’ll pay MIPs for the life of your loan. If you put down 10% or more, you only have to pay MIPs for the first 11 years of your loan.
Homeowners insurance protects you against major financial losses when your home suffers damage. It also protects your mortgage lender or investor, who has a major stake in your home since it’s the collateral for your loan.
Unlike mortgage insurance, homeowners insurance directly benefits you. It’s designed to make you whole after a covered loss. That means you’ll get money to make your home safe and comfortable and replace damaged or stolen possessions.
As long as you have a mortgage, your loan servicer will require you to carry enough homeowners insurance to rebuild your home in the event of a total loss. After that, it’s up to you, but you’ll probably want to keep your coverage to protect one of your biggest assets.
Comparing mortgage insurance and homeowners insurance
Here’s a quick breakdown of how mortgage insurance and homeowners insurance compare:
|Mortgage insurance||Homeowners insurance|
|Who benefits directly||Mortgage company||Homeowner|
|Who benefits indirectly||Homeowner||Mortgage company|
|When it's required||When you have less than 20% equity at the time you take out your mortgage||Until your mortgage is paid in full|
|Who pays for it||Homeowner||Homeowner|
|Cost||Based on carrier, home equity, loan term, and credit||Based on carrier, cost to rebuild, and insurance score|
|Homeowner chooses provider||No||Yes|
Learn More: How to Compare Home Insurance Quotes
Is homeowners insurance included in my mortgage payments?
Your homeowners insurance might be included in your mortgage payments. If you have an escrow account, which lenders often require when your down payment is less than 20%, it probably is.
To find out, check the itemized portion of your monthly mortgage statement. It should show any payments you’re making that aren’t principal and interest and what these payments are for. You may be paying one-twelfth of your annual homeowners insurance premium to your mortgage servicer each month.
The servicer puts this money into an escrow account until your annual premium is due, then uses the money from that account to pay your bill. It’s a way for your lender to make sure you’re keeping up with your mortgage obligations.
Does my mortgage lender require homeowners insurance?
Yes, your mortgage lender will require you to carry homeowners insurance. Before your loan can close, you’ll have to apply for a policy and send the declarations page to your lender.
Here’s why this insurance requirement exists: If your home burns down, you’re uninsured, and you don’t have much home equity, it might make financial sense for you to walk away and leave your loan servicer to deal with the debris removal, rebuilding, and sale even though your credit score will tank.
Your loan servicer doesn’t want that responsibility, so it requires you to carry enough homeowners insurance to completely rebuild your home in case of a total loss. And if you decide not to rebuild, the insurance money will make it possible to pay off your mortgage.