Your lender might ask for proof of homeowner’s insurance and mortgage insurance when you purchase or refinance a house. Mortgage insurance and homeowners insurance are not the same thing, even though they may sound similar. Both types of insurance cover different things. In some cases, one or both of these types of insurance may be necessary. Both are payable by the borrower.
Home insurance vs. mortgage insurance
What it covers is the key difference between home and mortgage insurance. Mortgage insurance protects the lender, while homeowners insurance protects the borrower.
Homeowners insurance protects you and your home from the most devastating financial losses such as fires or storms. Homeowners insurance can pay for damages to your home. Private mortgage insurance (PMI) protects the lender from borrowers not repaying the loan. This is especially true if you pay less that the standard 20% down payment. Certain loan types require mortgage insurance throughout the loan’s life, while others allow for cancellation after the principal amount of the mortgage has been repaid. PMI is required until the mortgage is paid off to ensure that you are no longer considered high-risk.
| Insurance for homeowners | Insurance for mortgages | |
|---|---|---|
| Covers | Indirectly, the homeowner and the lender | The lender |
| It does not include: | Flooding and arson are not usually covered. Sinkholes are not usually covered by all providers. An endorsement may be possible for earthquake coverage. | The homeowner |
| Requirements for: | Borrower financing their home purchase | Borrower who makes a lower down payment. Usually, less than 20% of the purchase price. |
| Form for payment: | The premium is paid directly to the insurance company by the borrower or to an escrow account that the lender manages. | Borrower pays monthly payment and/or a portion for closing costs of home purchase to the insurer as determined by lender |
| Average annual cost: | *$1,477 to $250K for dwelling coverage | The loan amount can be 0.3% to 1.5% |
Insurance for mortgages
A bank or lender will take a chance that you will pay back your mortgage when you borrow money to purchase or refinance a house.
Lenders are looking for borrowers with low risk:
- Credit history with good standing
- Steady employment
- Low ratio of debt to income
- A 20% down payment or more on the property’s sale price
Many borrowers have a good credit score but don’t have enough money to buy their property. This could be a red flag for a lender. Lenders may see it as a red flag if a person does not make a substantial down payment towards the purchase. This is where PMI comes into play.
What is PMI?
Private Mortgage insurance protects a lender or bank if you default on your mortgage payment and leave the house. PMI provides a bank or lender with a guarantee that it will not be held responsible for your loss if you fail to pay your mortgage and walk away from the home.
PMI is required when you have a conventional loan on your home and pay less than 20% down. If your equity exceeds 20% of the home’s value, you will also need PMI.
How much does PMI cost?
The average cost of PMI annually is 0.5% to 1% of the loan amount. An additional $208 per month for a $250,000 mortgage would cost you $2,500 annually or $2,500 per year. The Consumer Financial Protection Bureau states that PMI is typically paid in conjunction with the monthly mortgage premium. However, it may also be paid at closing. Review your loan estimate and close disclosure to find out the PMI terms.
PMI is provided by private insurance companies and is arranged by the lender. You may be offered payment options by a lender, although they may not offer them. These most popular ways to purchase PMI include:
- Your mortgage payment will be subject to a monthly premium
- One-time, up-front premium payable at closing
- Combination of one upfront payment and monthly premiums
What can I do to avoid PMI?
There are many ways to avoid paying PMI
- You could save more if you delay your home purchase to save money on down payments. This could help you avoid paying PMI.
- Ask your lender to pay: Lender-paid mortgage insurance (LPMI) is a type of coverage that some lenders will pay. This route is not for everyone. You could get a higher mortgage interest rate.
- Piggyback mortgages: You can have two mortgages instead of one. This is usually done in an 80/10/10 split with an 80% mortgage, a 10% second mortgage and 10% down payment.
- Look for a lender that offers low down payments and no PMI. This could be for first homebuyers or low-income buyers or those in certain professions like teachers or doctors.
- You can get a mortgage through Veterans Affairs (VA) if you are eligible.
Is PMI tax deductible
PMI was originally tax-deductible. However, it was eliminated in 2017 by the Tax Cuts and Jobs Acts. In 2019, it was reintroduced with the Further Consolidated Appropriations Act. It became effective in 2020. You must itemize your deductions to deduct PMI from federal taxes. This is an alternative to taking the standard deduction.
What is the minimum amount I must pay for PMI?
You may need to pay the entire term of an FHA Loan if you purchase your home using an FHA Loan . You can request removal of PMI if you have a conventional loan. This happens when your home has 20% equity, based on either the appraised value or the purchase price. There are four methods to get PMI removed from your mortgage.
- You can request cancellation of your PMI by writing if you are below the 80% mark. You will need to be current with your payments and have a track record of good payments. In some cases, you might be asked to prove that the value of the property has not decreased and that there are no other mortgages.
- Automatic termination: The servicer must immediately terminate PMI when the principal balance exceeds 78%.
- Final termination: The lender must end PMI once you reach the halfway point in your mortgage’s amortization plan. The midpoint of a 30-year loan would, for example, be after 15 years worth of payments. This is regardless of whether you have paid 78% or not.
- Refinance: You may be eligible to refinance an existing mortgage to get rid of PMI if you own your home for at least 80% of the time. If your new loan balance is less than 80% of the value of your home, refinancing may be possible.
Private mortgage insurance covers the lender, not you, if you default on your mortgage payments. Your credit score and your ability to pay your mortgage on time will be affected. You may even lose your home.
What is homeowners insurance?
Your home and property are protected from financial losses such as fires and storms by homeowner’s insurance. Without homeowners coverage you would need to replace your entire household or rebuild your home.
Even if your lender doesn’t require you to have insurance on your home, it’s a smart financial decision. The premium for home insurance is low when compared to the cost of replacing or repairing a house and other belongings in the event of a loss.
To purchase the correct amount of homeowners insurance, consult an experienced insurance professional.
What is homeowners insurance?
Depending on the type of homeowner insurance policy you select, there are different coverage options. You may be able to have your dwelling or personal property replaced at the actual cash value, or at replacement cost. Open perils coverage and named perils coverage may be available.
In general, most standard homeowners’ insurance policies will cover the following categories in the event of a covered claim.
- At replacement cost, your home’s dwelling and detached buildings
- Your personal property (at the actual cash value).
- Personal liability for lawsuits arising from injuries and accidents on your property
- Living expenses for those who are disabled and unable to rent a home
The most common covered events are damage to or loss of your property that results from:
- Explosions
- Fire
- Hail
- Lightning strikes
- Theft
- Vandalism
- Windstorms
Most home policies don’t cover earthquakes, flooding or sinkholes. These perils can be covered by an insurance rider or separate policy. Flood insurance can be purchased through NFIP (National Flood Insurance Program).
Why is my mortgage lender requiring me to have home insurance
Lenders want to protect their investment. Lenders want to see that you are able to fix your home and continue to make mortgage payments. If your home is totaled, they will also require you to repay any outstanding balance.
What homeowners insurance covers if my house is destroyed by a fire?
Your standard homeowners policy will cover the cost of replacing your contents, property and structure in the event of fire. Additional living expenses coverage is available if you have to live somewhere else while repairs are being made.
The bottom line
Private mortgage insurance and homeowners insurance both cover your home. However, homeowners insurance is primarily designed to benefit you. Private mortgage insurance can cost hundreds of dollars per monthly in premium payments to protect your lender. It is not often a preferred way to finance a home.
Your financial risk is reduced by homeowners insurance if your property or home suffers major damage. This insurance covers the costs of replacing or repairing your property and pays you directly. It is a worthwhile expense.