Becoming a homeowner requires you to get to grips with a wide range of things you might not have ever considered before. Homeowners and mortgage insurance can be confusing at first and it can be difficult to know if you need them or not. This guide will help you understand the differences between the two, and clarify any misunderstandings.
What is Homeowners Insurance?
Homeowners insurance, or home insurance, is a type of insurance that protects an individual’s property and assets in case of loss or damage. The coverage typically includes damage done to the interior and exterior of the building, theft, accidental water damage, fire and smoke, living expenses in case your home is unlivable, and so on.
It also covers homeowners in case of accidents that happen on their property, as well as liability claims. This type of insurance will also protect your home and assets in case of lightning or hail, yet coverage in case of earthquakes or flood damage (including damage caused by hurricanes) is not typically included in the standard policies.
Home insurance is not mandatory by law, however lenders will require it if you’re applying for a mortgage loan. Also, it’s best to note that if you live in a condo, you will need to apply for condo insurance instead.
Is Homeowners Insurance the Same as Home Warranty?
The two may sound similar, but homeowners insurance and home warranty are different. Home warranty does not apply to the property as a whole, but to the appliances, HVAC, plumbing, heating and electrical systems. Essentially, a home warranty safeguards the functionality of household items in case they break, while a homeowners insurance protects you in case of loss or damage to the property itself.
What is Mortgage Insurance?
Private mortgage insurance (PMI) is an insurance policy that protects banks and lenders should you default on your loan payments, whether it’s due to natural causes or financial distress. Depending on the lender and your down payment amount, lenders may or may not require it.
For example, a down payment of less than 20% of the loan amount will normally require private mortgage insurance. Additionally, if you have a mortgage loan with the USDA or FHA, you will normally be required to sign up for mortgage insurance regardless of the down payment you put upfront.
What Are the Differences?
Let’s take a look at what sets homeowners insurance and mortgage insurance apart.
The main difference between homeowners and mortgage insurance is what is covered by the insurance policy. Mortgage insurance is pretty straightforward: it only protects the lender, in case homebuyers default on their loan payments. On the other hand, homeowners insurance protects the individual’s property and assets, and as a result, it also protects the lender indirectly.
If you already own the home you live in and have paid off your mortgage loan, homeowners insurance is not mandatory, yet it’s always a good idea to have one in place. However, if you’re applying for a loan, your lender will generally require you to have one as a condition for your loan approval.
Mortgage insurance is required if you’re applying for a loan with less than 20% on your down payment. You will also require a PMI if you’re thinking of refinancing your mortgage, and your home equity is less than 20% of your home’s value.
Homeowners insurance is always paid through monthly installments to the insurer. In the case of conventional mortgage insurance, you have several options: you can either pay the full amount upfront, split it in monthly payments (whether in the form of an additional monthly fee or a higher interest rate), or combine the two, by paying an upfront premium of up to 1.25% of the loan amount, and the rest in monthly payments.
On average, homeowners insurance contracts have a 12 months term before you need to renew them, although lifetime insurance is also available. With mortgage insurance, the term length can vary greatly depending on the type of insurance, as well as the lender. In most cases, if you’ve opted for monthly payments, you will need to make them until you have accumulated 22% equity in your home, which can take up to 11 years.
The average homeowners insurance premium is around $1,200 per year. In the case of PMI, the yearly costs tie in with the loan amount, ranging between 0.5% and 1.5%. Depending on how much you’ve borrowed, you can end up paying almost twice as much per year in mortgage insurance compared to homeowners insurance.
Private Mortgage Insurance is Tax-Deductible (for now)
If you have conventional private mortgage insurance (PMI) with your lender, you’ll be pleased to know that it is still tax-deductible until the end of 2020. However, this does not apply to mortgage insurance on government-backed loans, such as USDA or FHA loans. As for home insurance, it is still not tax-deductible in the vast majority of cases.