Private mortgage insurance (PMI) provides financial protection to your lender in case you default on your mortgage payments. If you have a conventional loan (not federally-backed) and made a down payment of less than 20 percent, or if you refinance your home loan with less than 20 percent equity, PMI may be included in your monthly mortgage payment. Bankrate’s insurance editorial team delves into the distinctions between mortgage insurance and home insurance to help you understand the differences.
Mortgage insurance vs. home insurance
The primary distinction between mortgage insurance and home insurance lies in whom they financially protect. Homeowners insurance primarily safeguards both the borrower’s and lender’s investment in the property, ensuring coverage in case of damage or destruction by a covered peril. It also guarantees that the property insurance will cover the remaining mortgage balance. Conversely, mortgage insurance shields the lender’s investment in the property if the homeowner defaults on the loan. In essence, while home insurance safeguards both your and your lender’s finances, private mortgage insurance exclusively protects the lender’s interests.
Mortgage insurance
Private mortgage insurance (PMI), also referred to as mortgage insurance, provides financial protection to mortgage lenders in the event of default by the borrower, i.e., the homeowner. For conventional loans, borrowers are typically required to pay for PMI if their down payment is less than 20 percent when purchasing a home. PMI premiums are usually automatically terminated after a certain portion of the mortgage is repaid, typically when the loan-to-value ratio reaches 78 percent. Borrowers of FHA and USDA loans who make down payments of less than 20 percent also typically have to pay mortgage insurance premiums (MIP), which, in most cases, cannot be canceled.
Homeowners insurance
Homeowners insurance, also known as hazard insurance, safeguards your home’s structure and property against significant financial losses caused by events such as fires, storms, and other perils outlined in your policy. If your home sustains damage covered by your policy, your insurance company will typically cover the repair costs, minus your deductible. If you have a mortgage, you will likely need to maintain homeowners insurance to safeguard your mortgage company’s financial stake in your property.
Distinguishing between the two insurance types can be perplexing. The table below outlines some of the disparities between mortgage insurance and homeowners insurance:
| Homeowners insurance | Mortgage insurance | |
|---|---|---|
| Covers | Homeowner directly and mortgage lender indirectly | Mortgage lender |
| Does not cover | A standard homeowners insurance policy usually does not provide coverage for property damage resulting from incidents like arson, flooding, sinkholes, mudslides, and earthquakes. It’s important to review your own policy for specific details regarding coverage | The home’s structure, the homeowner or their personal property |
| Typically required for | A borrower financing their home purchase with a home loan | A borrower making a lower down payment, usually less than 20% of the home’s purchase price |
| Payment form | Typically, the policyholder pays the premium directly to the insurance company or through the mortgage company, which manages the homeowners insurance from the escrow account | The borrower makes monthly payments and/or contributes a portion of the closing costs of a home purchase to the mortgage insurer designated by the lender |
| Average annual cost | $2,151 annual premium for $300K in dwelling coverage | 0.46% to 1.5% of the original loan amount, or $30 to $70 per month for each $100,000 borrowed |
What is PMI?
PMI is an additional fee paid by the borrower to their financial lender. When obtaining a loan for home purchase or refinancing, the bank or financial institution expects you to fulfill the loan terms and make timely mortgage payments. Private mortgage insurance, or PMI, safeguards the lender in case you default on your mortgage or abandon the property, leading to foreclosure. PMI offers the lender assurance that their risk will likely be mitigated when lending money to you, the borrower.
PMI is typically required with conventional home loans when the down payment is less than 20% of the home’s purchase price. Similarly, during refinancing, if your home equity is below 20% of the property value, PMI might be mandated.
Many borrowers may be deemed low-risk but lack sufficient funds for a 20% down payment, which could concern lenders. In such cases, a borrower’s inability to make a substantial down payment may raise doubts about their long-term ability to afford higher monthly mortgage payments. PMI serves to address this concern and may thus be incorporated into your loan terms.
How much does PMI cost?
The typical cost of PMI typically ranges from 0.46 percent to 1.5 percent of the original loan amount, equating to an extra $30 to $70 in monthly expenses for every $100,000 borrowed. However, the precise cost can be influenced by factors such as your loan type, credit score, and loan-to-value ratio. PMI is typically paid as part of your monthly mortgage premium, though it can also be paid as a lump sum upfront during closing. The specific terms of PMI are outlined in your loan estimate and closing disclosure.
PMI is organized by the lender and provided by private insurance companies. While the lender may offer payment options, you can also request alternatives. The most common payment methods for PMI include:
- Adding a monthly premium to your mortgage payment
- Paying a one-time upfront premium at closing
- A combination of an upfront payment and monthly premiums
How can I avoid paying PMI?
Aside from making a larger down payment, improving your credit score, or exploring different loan options, there are a few other strategies to avoid paying PMI:
- Ask the lender to cover the cost: Some lenders offer to pay for your mortgage insurance, known as lender-paid mortgage insurance (LPMI). However, this may result in a higher interest rate on your mortgage.
- Consider a piggyback mortgage: Instead of a single mortgage, you could opt for two mortgages. This is often structured as an 80/10/10 split, with an 80 percent first mortgage, a 10 percent second mortgage, and a 10 percent down payment.
- Find a lender with its own mortgage insurance program: Certain banks and credit unions offer portfolio loans that don’t require mortgage insurance. These lenders may be more flexible in their lending practices.
- Explore down payment assistance: Down payment assistance programs can help you increase your down payment, potentially allowing you to surpass the 20 percent threshold and avoid PMI.
How long do I have to pay for PMI?
With a conventional private lender loan, once your home’s equity reaches 20 percent based on the appraised value or purchase price (whichever is lower), you can typically request the removal of PMI. Here are several ways to remove PMI from your mortgage:
- Request cancellation: Once you achieve an 80 percent loan-to-value ratio, you can submit a written request to have your PMI canceled. You must be up-to-date on payments, demonstrate a good payment history, and may need to provide evidence that the home’s value has not declined, with no additional mortgages or liens. It’s important to note that this calculation is based on the original appraised value at the time of sale, not the current market value of your home.
- Automatic termination: When the principal balance reaches 78 percent of the original home value, PMI must be automatically terminated by the mortgage insurance servicer.
- Final termination: Once you reach the midpoint of your mortgage’s amortization schedule, PMI must be removed by the lender. For instance, with a 30-year loan, this would typically occur after 15 years of payments, regardless of whether you’ve reached 78 percent of the original value.
- Assess your home’s value: After making regular mortgage payments for at least two years, you can request a broker price opinion (BPO) from your lender to determine the current market value of your home. If the new value, along with your mortgage balance, results in a 75 percent loan-to-value ratio, PMI is eliminated. After five or more years in the home, this threshold increases to 80 percent loan-to-value.
- Refinance: If you meet the lender’s eligibility criteria after owning your home for a sufficient duration, you may refinance your existing mortgage into a new loan to remove PMI. Typically, you need at least 20 percent equity in your home to qualify. However, refinancing can be costly, so it may not be financially prudent solely to eliminate PMI. But if you were planning to refinance your mortgage anyway, this could be a viable strategy.
Remember, private mortgage insurance protects the lender’s financial interests, not yours. Failing to make timely payments can negatively impact your credit score and may lead to default on the loan terms, potentially resulting in foreclosure.
What is homeowners insurance?
Homeowners insurance shields you from significant financial losses if your home’s structure, other structures, or personal belongings suffer damage or destruction due to a covered peril. Without this insurance, you would probably bear the burden of repairing your home or replacing your belongings, which might not be feasible depending on your financial situation. According to Bankrate’s 2024 annual emergency savings report, a majority of American adults lack $1,000 in disposable income for a family emergency. Thus, covering home repairs or replacements out of pocket is unrealistic for most homeowners. Additionally, a home insurance policy provides liability coverage, which can be beneficial if you’re held responsible for someone else’s injuries on your property.
Even in cases where your lender doesn’t mandate home insurance or when your home’s mortgage is paid off, most financial advisors advocate for purchasing home insurance to safeguard your home investment. The premium for home insurance is typically minimal compared to the expenses associated with repairing or replacing a home and belongings without coverage.
To ensure you have adequate coverage, you may consider seeking guidance from a licensed insurance agent to compare home insurance quotes and select the appropriate level of homeowners coverage.
What does homeowners insurance cover?
Homeowners insurance policies offer varying levels of protection tailored to the policyholder’s preferences. For instance, a policy may provide coverage to replace personal property either at actual cash value or replacement cost. Additionally, the policy might include open perils coverage or named perils coverage, depending on the type of home insurance policy.
Typically, standard homeowners insurance policies encompass the following coverage types:
- Dwelling coverage: Protects the physical structure of your home.
- Other structures coverage: Covers additional structures on your property, such as detached garages, fences, and gazebos.
- Personal property coverage: Insures your personal belongings, including furniture, clothing, and electronics.
- Medical payments coverage: Pays for certain medical expenses if a visitor is injured in your home.
- Liability insurance: Shields against financial losses if you’re held legally responsible for others’ personal injuries or property damage.
- Additional living expenses coverage: Assists with extra costs incurred while living elsewhere during home repairs after a covered claim, including hotel expenses, food, and pet boarding.
The most common perils covered by homeowners insurance include:
- Fire and smoke
- Windstorms and hail
- Lightning strikes
- Explosion
- Vandalism and malicious acts
- Aircraft or vehicle damage
- Theft
- Falling objects
- Weight of ice, snow, or sleet
- Water damage (excluding floods)
Typically, standard home policies do not cover earthquakes, floods, mudslides, or sinkholes. To obtain coverage for these perils, you may need to purchase a standalone policy or add a separate endorsement for an additional fee. Flood insurance, for example, can be acquired through the federally backed National Flood Insurance Program or private insurers. Your insurance agent can assist you in securing these additional coverage types.
How much does home insurance cost?
The national average annual cost of home insurance stands at $2,151 for a policy with a $300,000 dwelling limit. However, this figure serves merely as a benchmark for comparison purposes. Your specific home insurance rate will be determined by various factors unique to your situation, including your location, the age of your home, deductible amount, policy type, claims history, and more. Additionally, factors such as your credit-based insurance score and marital status may impact the premium amount, varying by state.
Is homeowners insurance required?
Homeowners insurance is not mandated by federal or state law. Nonetheless, the majority of mortgage lenders necessitate this coverage for as long as they maintain a financial stake in the property. It’s widely advised by insurance professionals to invest in homeowners insurance to safeguard your financial commitment to your home and mitigate the risk of substantial out-of-pocket expenses in the event of a covered disaster. Depending on your residence and its location, you may discover reasonably priced home insurance options from some of the most economical home insurance companies.