Homeowners Insurance vs. Mortgage Insurance
Homeowners insurance and mortgage insurance are two types of insurance that can raise the cost of owning a home, and you're likely to come across both during the mortgage process. However, that is where their resemblance ends.
Here's the main distinction. Your home and its contents are protected by homeowners insurance. Mortgage insurance (also known as private mortgage insurance or PMI for short) protects your mortgage lender in the event that you are unable to make your mortgage payments.
Homeowners Insurance vs. Mortgage Insurance
Though homeowners insurance and mortgage insurance may appear to be the same thing, they are not. Here's a quick rundown of each.
What Is Homeowners Insurance?
Homeowners insurance is a type of property insurance that protects your home and its contents against damage caused by unforeseen events. Furthermore, most homeowner's insurance protects you from lawsuits if someone is injured on your property. It also protects your home and belongings from damage or loss-related expenses. This insurance is ideal for anyone who wants to protect their home and belongings.
- A homeowners insurance policy may include coverage for your:
- Home’s structure
- Personal belongings
- Liability in lawsuits for injuries caused by you, your family members, and your pets to others
- Medical expenses if someone is hurt in your home
- Extra living expenses while your home is uninhabitableÂ
There are, however, constraints. Natural disasters such as floods, mold, earth movements such as earthquakes and landslides, and sewer or drain backups or overflows are typically excluded from standard homeowners insurance policies.
What Is Mortgage Insurance?
Mortgage insurance (also known as PMI) is not the same. This is an insurance policy designed to protect the lender—say, a bank—if you are unable to make your mortgage payments.
The homeowner typically pays a percentage of their total mortgage cost each year with PMI. The insurance company will then pay the lender on their behalf if they are unable to make mortgage payments. Including PMI in your monthly bills can raise the cost of home ownership.
Key Differences
The key differences between these two types of insurance are as follows:
 | Homeowners Insurance | Mortgage Insurance |
Covers | Homeowner directly and mortgage lender indirectly | Mortgage lender |
Does not cover | A standard homeowners insurance policy typically excludes coverage for property damage caused by losses such as arson, flooding, sinkholes, mudslides and earthquakes | Mortgage Lender |
Required for | A borrower financing their home purchase | A borrower making a lower down payment, usually less than 20% of the home’s purchase price |
Payment form | Generally, the policyholder pays the premium directly to the insurance company or to the mortgage company, which then pays the homeowners insurance from the escrow account managed by the lender | Borrower pays monthly payments and/or a portion of closing costs of a home purchase to the mortgage insurer set by the lender |
Average annual cost | Nationwide average of $1,251 per year | The cost depends on three factors: the loan amount, your credit score, and your loan-to-value (LTV) ratio. For property worth $250,000, the cost ranges from $1,091 to $1,747 per month |
Data from National Association of Insurance Commissioners, "NAIC Releases Report on Homeowners Insurance," and Urban Institute, "Housing Finance at a Glance."
Do I Need Homeowners Insurance or Mortgage Insurance?
The type of insurance you require is determined by the type of mortgage you have, the size of your down payment, and how close you are to repaying your mortgage.
Do I Need Homeowners Insurance?
The majority of homeowners have some form of homeowners insurance. This is due in part to the fact that lenders frequently require them to obtain homeowners insurance in order to obtain a mortgage. However, many people have homeowners insurance for its own sake and continue to pay for it even after their mortgage is paid off.
Because of the high replacement cost of homes and the high cost of lawsuits, homeowners insurance can make good financial sense. Monthly premiums can be much lower than the cost of rebuilding your home or replacing all of your possessions in the event of a covered disaster, or if you are sued because a visitor was injured.
Do I Need Mortgage Insurance?
The answer is determined by your lender.
Borrowers are typically required to obtain mortgage insurance if their down payment is less than 20% of the home's purchase price. This is true if you are taking out a conventional loan or refinancing your home and your equity is less than 20% of its value. A mortgage insurance premium (MIP)—the equivalent of PMI—is always required for Federal Housing Association (FHA) mortgage loans.
This is because lenders consider mortgages with less than a 20% down payment to be risky, and they want protection in case you can't make your payments.
You can, however, cancel your PMI after you've paid off a significant portion of your mortgage. The rules in this regard vary, so check with your lender to find out what their policies are. In general, you can cancel your PMI when your principal balance reaches 80% of the original value of your home. This is determined by the contract sales price or appraised value at the time of purchase (whichever is lower). When requesting cancellation, you must have a track record of making on-time payments and be current on your bills.
FHA loans have their own set of guidelines. Your loan terms may require you to maintain your MIP for 11 years, or the length of your mortgage, depending on your loan-to-value ratio (LTV) when you took out your FHA loan.
Are Mortgage and Homeowners Insurance Interchangeable?
No. Your home and its contents are protected by homeowners insurance. Mortgage insurance (also known as private mortgage insurance or PMI for short) protects your mortgage lender in the event that you are unable to make your mortgage payments.
Do You Always Need Mortgage Insurance?
Borrowers who make a down payment of less than 20% of the purchase price of a home will typically be required to pay mortgage insurance. Mortgage insurance is usually required on FHA and USDA loans as well.
How can I avoid PMI?
Making a down payment equal to 20% of the home's purchase price is one way to avoid paying PMI. If you are required to purchase PMI, do not try to avoid doing so. In that case, your lender can purchase it on your behalf and charge you, which may be more expensive than purchasing it yourself.
The Bottom Line
As you go through the mortgage process, you will come across both homeowners insurance and mortgage insurance, but they are very different types of insurance.
In the event of a lawsuit, homeowners insurance protects your home, its contents, and you. Mortgage insurance, also known as PMI, protects your lender (for example, the bank) in the event that you are unable to make your mortgage payments.
The majority of homeowners have homeowners insurance because it can make good financial sense to protect yourself from unexpected costs. If your down payment is less than 20% or you obtain an FHA loan, you will be required to purchase PMI on top of your mortgage.