Homeownership 101: Homeowners Insurance vs Mortgage Insurance
These two will likely crop up when you buy a home. It’s true, both homeowners insurance and mortgage insurance protect your home. But they are two separate policies set to affect you differently.
As you transition from a homebuyer to a homeowner, knowing their difference is an advantage. This is so you can prepare yourself and your pockets over these homeownership-related expenses. What’s in each of homeowners and mortgage insurance policy for you?
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Two Home Insurance Policies, Two Different Beneficiaries
Let’s start with their definition.
Homeowners insurance protects your home against damage from natural disasters, e.g. wildfires, storms and hurricanes. It also covers losses arising from fire, vandalism and theft. Covered events and exclusions depend on the insurance package you buy.
Then there’s mortgage insurance. It’s an expense that is triggered when you put less than 20% of the purchase price as down payment on a home. This is called private mortgage insurance or PMI. On FHA loans, which have down payments as low as 3.5%, they are known as mortgage insurance premiums or MIPs.
So, who benefits from which insurance policy?
It’s natural for lenders to require homeowners insurance on a mortgaged property. Until this mortgage debt is paid off, the lender retains interest in the property and wants to protect it.
Of course, when you bought the property in cash, you won’t be compelled to buy homeowners insurance. Still, homeowners insurance whether it’s required or not ultimately protects YOU.
Mortgage insurance, on the other hand, is taken out on behalf of the lender or bank. This protects THEM from the risk of lending you money to buy a home despite a smaller down payment. It’s their safety cushion should you default on your loan.
Who pays for these home-related policies?
YOU. Your homeowners insurance premiums can be included in your monthly mortgage’s PITIA. In some cases, you have to pay these premiums directly to the insurer.
You are also responsible for your PMI/MIPs. It’s up to the lenders on how these insurance premiums are collected, upfront, monthly, or both.
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Eliminating PMI, MIPs
But you may not have to pay PMI throughout the life of the loan. For example, you have built home equity that your loan-to-value ratio reaches 80%. You can ask your lender to cancel your PMI. If the LTV further drops to 78%, then the PMI will be canceled automatically.
You can also refinance to get rid of your PMI but be sure that equity built in your home is 20%.
Eliminating MIPs on FHA loans is a different case. MIPs are paid upfront or UFMIP and yearly via monthly payments referred to as annual MIPs. Upfront MIPs can’t be canceled: you have to pay them every time you take out an FHA loan.
As to annual MIPs, borrowers were once allowed to drop them if they reach 78% LTV. But recent FHA rules indicate that those who made 3.5% down payment will have to pay them for the life of the loan.
To eliminate MIPs would mean paying off the loan or refinancing into a conventional loan. On the bright side, homeowners who refinance their FHA loans with another FHA loans called streamline refinance pay reduced annual MIPs.
To sum things up
Essentially, homeowners insurance is a must for all homeowners to protect them against economic losses when their home is damaged by fire or struck by lightning. Mortgage insurance serves to protect the banks for lending money despite the low down payment.
For your home’s sake, you can do without mortgage insurance. But that’s certainly not the case with homeowners insurance with all natural and human-caused contingencies out there.
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