Mortgage Insurance vs. Homeowners Insurance

August 22, 2012 No Comments »
Mortgage Insurance vs. Homeowners Insurance

These days, it seems as if we can insure just about anything. While this may be perceived as “great news!” by overzealous insurance agents, for individual consumers it’s just more money down the drain.

After all, paying for insurance always feels like a chump’s game until you actually need to file a claim, which never seems to happen if you actually have insurance in place.

When you purchase a home, your insurance needs will certainly rise, which will put even more strain on your newly inflated finances.

That said, let’s look at two common forms of insurance tied to homeownership, and explore what each provides.

Mortgage Insurance Protects the Bank

You may have heard about mortgage insurance, especially if you’re putting very little down on a home. Or arguably, even a lot.

And contrary to what you might believe, mortgage insurance doesn’t do anything to protect the homeowner.

Conversely, it serves to protect mortgage lenders in the event of borrower default, something they deem necessary when you’re putting down less than 20% on a home purchase.

In short, you’re paying for the risk you present to the lender, and until your loan-to-value ratio (LTV) dips below 80%, you’ll continue to pay that premium.

If you take out a conventional loan above 80% LTV, you’ll need private mortgage insurance (PMI), which your lender will facilitate when going through the loan process.

If you take out an FHA loan, you’ll get mortgage insurance through the FHA. For the record, the FHA recently increased premiums to buffer their reserves.

So we know a little more about mortgage insurance, but let’s talk about what it isn’t.

It is not insurance that protects you in the event you can’t make your mortgage payment.

Put simply, if you lose your job or fall ill and are unable to make payments, mortgage insurance does not cover you.

That’s a different product known as “mortgage protection insurance.” Yes, there’s insurance for every single possible situation folks!

It also doesn’t cover you if your home value falls, or if anything else nasty happens to your home or your mortgage. Again, it’s not for YOU. It’s for the lender! And you pay for it!

Yet another reason to put 20% down when buying a piece of property. The other reason is a lower mortgage rate, generally.

Homeowners Insurance Protects You

I assume a lot of individuals get homeowners insurance and mortgage insurance confused, and for good reason.

They both sound pretty similar, but they really share nothing in common.

Homeowners insurance is actually in place to protect YOU, the homeowner, from perils that exist and may cause damage and monetary loss.

So if a fire burns down your home, or a tree crashes through your roof, your homeowners insurance should be triggered, and the company should pay to fix any damages, less your deductible.

In other words, homeowners insurance serves the owner of the home, instead of the lender. It also has nothing to do with your home loan, though there is some overlap.

Technically, if you own your home outright, you don’t NEED to get homeowners insurance. But you’d be pretty foolish not to purchase it.

Without it, you’d expose yourself to major financial risk, which clearly isn’t wise with insurance premiums being relatively cheap in the grand scheme of things.

And you certainly wouldn’t want to jeopardize your ability to make mortgage payments if all your money was caught up in home repairs.

Of course, most individuals don’t actually own their homes free and clear, and thus MUST take out homeowners insurance policies, again, to protect the lender’s interest.

At this point, you may be thinking it’s all about the lender. But when it comes down to it, you’ve got a massive loan on the property, so it’s really the bank’s more than it is yours.

And without insurance in place, in the event of a major loss, most homeowners would probably run, not walk, away from the property.

Lenders know this, which is why they demand that you buy homeowners insurance.

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