There’s nothing more exciting than becoming a homeowner. If you are a prospective homeowner, it’s likely that you are reviewing a lot of insurance information for your home purchase.

Homeowners insurance and mortgage insurance, while both important, offer completely different types of coverage to homebuyers.

In the event that you default on your mortgage, mortgage insurance is used to pay your mortgage lender. On the other hand, homeowners insurance is used in the event that your property suffers damage.

Here’s a more detailed look at the difference between homeowners insurance and mortgage insurance.

What is Homeowners Insurance?

Homeowners insurance is a type of insurance that provides coverage for homeowners. Similar to buying car insurance for your car, when you buy a home you also have to purchase homeowners insurance.

This coverage covers expenses to help homeowners repair or rebuild their homes after certain events like fires, smoke, theft, vandalism, or a falling tree.

Homeowners’ insurance policies also cover any damage the weather might cause. This includes damage from lightning, wind, or hail.

Many standard homeowners insurance policies cover furniture, clothing, or other possessions. Homeowner’s insurance can also cover medical expenses and/or legal fees resulting from an injury that occurs while on the property.

Homeowners insurance usually covers four types of incidents on the insured property, including:

• Interior damage
• Exterior damage
• Loss or damage of personal assets/belongings
• Personal injuries

To become insured by homeowners insurance, homeowners must pay a premium, which is the annual amount they pay to an insurance company to keep the policy active.

When an insured homeowner makes a claim on any of those incidents, they must pay a deductible. A deductible is the out-of-pocket costs homeowners must pay before their insurance company will pay on the claim.

Additional read: Do I Need Homeowners Insurance And Who Should I Use?

What is Mortgage Insurance?

Mortgage insurance is an insurance policy that compensates lenders in mortgage-backed securities for losses that result from a borrower defaulting on a mortgage loan. Therefore, mortgage insurance primarily benefits the lender. When a lender faces a higher risk when extending a mortgage loan, they’re more likely to require mortgage insurance to cover any potential losses.

Whether or not a borrower has to pay mortgage insurance depends on the type of loan they’re applying for, the amount of their down payment, and the amount of the loan.

Additional read: Everything You Need to Know About Mortgage Insurance

What Are the Key Differences?

The major difference between mortgage insurance and homeowners insurance is the party the insurance policy is protecting. While mortgage insurance covers lenders directly, homeowners insurance covers the homeowner directly and the lender indirectly.

Another key difference is that lenders will always require homeowners insurance if you have a mortgage on your home. On the other hand, you only need to purchase a mortgage insurance policy in certain circumstances, which we’ll discuss in the following sections.

Mortgage Insurance by Loan Type

PMI

Private mortgage insurance (PMI) is a type of insurance that borrowers must purchase as a condition of a conventional mortgage loan.

PMI is similar to MIP (mortgage insurance premium) because it protects the lender’s investment in the home, not the borrower who’s purchasing the insurance. The difference is, with FHA loans, the buyer must purchase MIP no matter the size of the down payment.

Homebuyers who are able to make a down payment of 20% or more don’t need to pay for PMI.

The cost of PMI varies from borrower to borrower because it depends on a number of factors, including the borrower’s credit score, the amount of the down payment, and the loan-to-value (LTV) ratio.

FHA (MIP)

A mortgage insurance premium is a type of insurance policy borrowers must get when securing a Federal Housing Administration (FHA) loan.

An FHA loan is a mortgage insured by the FHA. which allows lenders to give borrowers better deals when it comes to down payment amounts, interest rates, and closing costs.

To get a MIP policy, homebuyers must pay a portion of the MIP at closing. They also must pay an annual premium, that’s divided amongst monthly mortgage payments.

More specifically, homebuyers must pay 1.75% of the loan amount towards MIP. Annual premiums range from 0.45 to 1.05% of the loan and are dependent on the loan amount, the loan term, and the down payment.

Because FHA loans allow homebuyers to put down a smaller down payment, lenders take on more risk. This is because a small down payment increases the amount of money a lender would lose if a buyer defaulted on the loan.

Mortgage insurance helps offset this risk by insuring the lender against potential loss. It’s important to note that mortgage insurance doesn’t protect buyers. Instead, it only protects the lender even though borrowers pay the premium.

VA Mortgage Insurance

Homebuyers that obtain VA mortgage insurance do so through a VA home loan. This means that they don’t have to pay for mortgage insurance, unlike regular loans.

As a result, homeowners don’t have to this cost to their monthly mortgage bill.

The VA home loan offers veterans many perks such as low down payment requirements and certain consumer protections.

However, to reap these benefits, veteran borrowers must pay a VA funding fee, which serves a similar purpose to mortgage insurance.

The veteran funding fee does essentially what it says, fund the VA mortgage program, allowing it to provide many benefits to veteran homeowners, while at the same time, reducing the burden on taxpayers. The veteran funding fee also helps lenders recover any losses.

The veteran funding fee is a one-time fee of 2.3% of a borrower’s loan amount and is due at closing.

This fee increases to 3.6% for homebuyers who have used the VA loan program before. They can reduce this amount by putting at least 5% down at closing.

Additional read: How Do VA Loans Work

USDA Rural Development Loans

The U.S. Department of Agriculture (USDA) offers mortgage loans to rural residents with low-income, who can’t get a conventional mortgage.

A USDA loan allows buyers to purchase a home with a zero down payment. To qualify for a USDA home loan, borrowers’ income must not be more than 115% of the area’s median income. And they also must not qualify for conventional financing without PMI.

USDA home loans technically don’t require mortgage insurance. However, they do require a guarantee fee, which works like mortgage insurance when helping to guarantee the home.

Whenever a homebuyer is bringing a low down payment, this increases the risk for the lender. Therefore, a government-backed loan like the USDA home loan requires a guarantee fee to provide insurance to the lender.

This means that if a borrower defaults on the loan, USDA pays the lender to help them recoup their losses.

The USDA home loan funding fee comes with two parts:

• Upfront fee: Borrowers must pay 1% of the total loan amount.
• Annual fee: Borrowers must pay 0.35% of the total loan amount.

Advantages and Disadvantages of FHA MIP

There are many benefits to obtaining FHA mortgage insurance, including:

• Set premiums: FHA mortgage insurance premiums don’t change according to credit score.
• Easier qualification: FHA loans are easier to qualify for than conventional loans. This is because mortgage lenders are able to absorb more risk. As a result, homebuyers with lower credit scores and down payments can obtain an FHA loan.
• Lower down payment: Homeowners who don’t have enough saved for a down payment can qualify for an FHA loan.

Even though FHA MIP comes with many advantages, there are a few downsides with obtaining this type of loan:

• Adds to overall loan cost: Because MIP requires an upfront cost, a borrower’s total loan amount and the monthly payment will increase.
• Difficult to get rid of: To get out of paying for FHA mortgage insurance, borrowers must either refinance into a conventional loan or pay off their mortgage in full.

Will I Need Homeowners Insurance After Paying Off My Mortgage?

Once you pay off your home, you’ll no longer have to pay for mortgage insurance. And technically, after settling your mortgage loan, you’ll no longer have a mortgage company requiring you to pay for homeowners insurance either. If you want full protection of your home, you’ll need homeowners insurance even after your mortgage is paid off.

As we discussed earlier in this article, mortgage insurance protects the mortgage lender’s interest, and not yours. In contrast, homeowners insurance protects you, your home, and certain items within your home.

Even though homeowner’s insurance isn’t required, it’s still a good investment that can be beneficial in the long run.

Which Type of Mortgage Insurance is Right for You?

Buying a home takes careful thought and consideration, especially when it comes to the extra costs that come with the big purchase. This is why it’s so important to have the guidance of a reputable lender to help you make a sound decision.

Interested in learning more about mortgage insurance premiums for your specific mortgage? A and N Mortgage can help. Contact us today for more information.

A and N Mortgage Services Inc, a mortgage banker in Chicago, IL provides you with high-quality home loan programs, including FHA home loans, tailored to fit your unique situation with some of the most competitive rates in the nation. Whether you are a first-time homebuyer, relocating to a new job, or buying an investment property, our expert team will help you use your new mortgage as a smart financial tool.