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Mortgage Insurance vs Homeowners Insurance: What's the difference?

Private mortgage insurance (PMI)  protects your mortgage, and homeowners insurance protects your home itself. While everyone needs homeowners insurance, not everyone needs mortgage insurance. If you can't put 20% down on a mortgage, your lender may stipulate private mortgage insurance as a condition of the loan in case you default on payments.

Private mortgage insurance protects your mortgage loan against default, while homeowners insurance protects your house and property against perils named in your policy.

In contrast to PMI, which protects the financing of your house, homeowners insurance protects the exterior and interior structure of your home and your personal belongings. Further, a standard homeowners policy will pay for your additional living expenses when your house becomes uninhabitable as well as claims that result from the bodily injury and property damage incurred by a visitor to your property.

What Is Private Mortgage Insurance?

To receive a conventional mortgage loan from a private lender, you are required to pay an up-front down payment, which is typically calculated as 20% of the total cost of the domicile. For example, the down payment on a $300,000 house would be $60,000. Without this downpayment, a lender may impose private mortgage insurance to protect themselves in case you don't make payments.

If you default on your mortgage—that is, fail to pay—your monthly payment, private mortgage insurance (PMI), also called "default insurance," steps in to pay the bill. While PMI underwrites your mortgage lender's investment, it does not safeguard you against the possibility of losing your home through foreclosure. It also does not cover the cost of damages to your home.

Mortgage insurance makes homeownership a possibility for folks who don't have the money on hand to make a standard down payment on a house. PMI gives a mortgage lender the confidence to approve a riskier-than-usual application, knowing that the mortgage will be paid by the PMI carrier in the event a homeowner cannot make their mortgage payments due to death, disability, sickness or job loss. However, PMI typically hikes up the price of your loan without the usual 20% down.

What Is Homeowners Insurance?

A standard homeowners insurance policy has four components, which are detailed on your policy's declarations page:

  • Dwelling, which protects the interior and exterior structure of your house against your policy's named perils.

  • Personal property, which protects your furniture, rugs, clothing, sports equipment, electronic equipment and other personal belongings.

  • Additional living expenses, which pays for your expenses over and above your usual budget when you must vacate your house because it has become uninhabitable due to a named peril.

  • Liability, which protects you against bodily injury and property damage claims made against you by a visitor to your property.

Overall, you should buy enough homeowners insurance to rebuild your house, based on its actual cash value or replacement cost value.

While a standard homeowners policy covers losses from many common perils, it does not protect your property against floods, earthquakes and landslides. Each of those perils requires a separate, stand-alone insurance policy.

Private Mortgage Insurance vs. Mortgage Insurance Premium

When you get a mortgage loan from a private mortgage lender, you are getting a "conventional" mortgage loan. In other words, a conventional loan is a loan that is not backed by the U.S. government. If you are required by the lender to get mortgage insurance for that conventional loan, you will be getting "private" mortgage insurance.

On the other hand, if you get a loan from the Federal Housing Administration (FHA), the U.S. Dept. of Veterans Affairs or the U.S. Dept. of Agriculture (USDA), you will be getting a "government mortgage loan." While all three of these government agencies offer their own mortgage insurance, only the FHA requires it for every loan. The FHA calls this mortgage insurance a "mortgage insurance premium" (MIP), part of which is paid up front and part of which is paid monthly.

PMI and MIP have varying costs, as both are based on the length of the mortgage loan and the loan-to-value ratio (LVR), which measures how much of your home is owned by your mortgage company and how much of your home is owned by you.

When you own 22% of your home, federal law says you can no longer be charged for PMI.

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How Much Is Private Mortgage Insurance (PMI)?

In 2020, 65% of customers who purchased private mortgage insurance were first-time home buyers and 35% were refinancing a home, according to the National Association of Insurance Commissioners.

Private mortgage insurance (PMI) generally costs around 0.2% to 2% of the loan amount per year "but can sometimes be much more," according to credit reporting agency Experian.

According to the Federal Home Loan Mortgage Corp, a PMI customer can expect to pay between $30 and $70 a month, on average, for every $100,000 borrowed. For example, a $200,000 home purchased with only a 5% down payment would require a $962.70 mortgage payment and a $80.75 PMI every month, according to Freddie Mac. A final per-year PMI cost depends upon a number of variables, including the insurer, the loan type, your credit score and your loan-to-value ratio.

How Much Is Homeowners Insurance?

The cost of homeowner insurance policies and conventional mortgage loans is based on the value of the home itself and where your home is located. Every home insurance carrier and every mortgage company has their own ways of determining a home's value.

You can expect to pay anywhere between $650 and $2000 a year in homeowners insurance premiums depending on a myriad of factors. If you file a claim on your home insurance policy, you will have to pay a deductible before the insurance company pays for repair or replacement.

How Long Must PMI Be Paid?

The loan-to-value ratio (LVR) is a measure of your home equity. If you make a 3.5% down payment on your mortgage loan, you have a home equity of 3.5% and an LVR of 96.5%. The more you pay off your mortgage, the more home equity you have. Once a borrower's home equity reaches 22%—in other words, the LVR falls to 78%—the mortgage lender must terminate the PMI by federal law, specifically the Homeowners Protection Act.

By federal law, a mortgage lender must stop requiring private mortgage insurance when you have achieved 78% home equity. 

Is Mortgage Insurance Included in My Mortgage?

If your mortgage lender requires you to have PMI as a condition of your loan, your mortgage lender will choose the PMI provider. Most mortgage lenders will combine the monthly cost of the mortgage payment and the monthly cost of the PMI payment into one monthly bill. This payment arrangement is called "borrower-paid monthly PMI." When the lender pays for the PMI upfront and rolls that expense into the mortgage itself, it is called "lender-paid PMI."

However, some lenders may demand that you pay the full PMI amount in one lump sum as a condition of the loan, an arrangement that's called "single premium PMI." If your lender requires you to make a down payment on your PMI and then pay the balance in monthly installments, that arrangement is called "split premium PMI."

When Is Homeowners Insurance Required?

There is no state or federal law that requires a homeowner to purchase home insurance. If you are financing the purchase of your home, however, your mortgage lender will require you to purchase home insurance to protect the lender's investment.

While the cost of PMI is typically based on the amount of the mortgage down payment, the cost of home insurance is based not on the mortgage down payment but on the cost of rebuilding your home.

Is Home Insurance Still Needed After a Mortgage Is Paid Off?

When you finally pay off your mortgage, you'll have 100% ownership of your house and a LVR of zero. If you want to continue to protect this significant asset after your mortgage is fully paid, you'll still need homeowners insurance. After all, the threat of fire, for example, will be just as likely after your mortgage is paid off as it was before. Note: Homeowners insurance is not tax deductible.

How To Find Cheap Homeowners Insurance

The cost of a mortgage, private mortgage insurance and home insurance can really add up. For one thing, private mortgage insurance increases the cost of holding a mortgage. However, if you put a 20% down payment on the mortgage of your home, condo or townhouse, you will avoid the extra costs associated with PMI. You can also lower your mortgage rate by improving your credit score. Another way to lower the overall cost of these services is to lower the cost for home insurance.

The best way to find the cheapest home insurance is to shop around, comparing home insurance companies and policies. SmartFinancial can do all the comparison-shopping for you by sorting through all the homeowners policies in your area to find the best, cheapest policy based on your profile. Just enter your zip code below or call 855-214-2291 for a free quote.

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