You are reviewing your closing disclosure and you see two insurance line items: homeowners insurance and mortgage insurance. You thought they were the same thing, or at least related. They are not. One protects you. The other protects your lender. You pay for both, but only one of them pays you a dime if something goes wrong.
Mortgage insurance and homeowners insurance are completely different products with completely different purposes. Confusing them is one of the most common mistakes first-time homebuyers make. Here is what each one actually does, who it protects, and why you are paying for both.
Homeowners Insurance: What It Covers and Who It Protects
Homeowners insurance protects you against damage to your property and liability for injuries that occur on your property. If a fire destroys your kitchen, your homeowners insurance pays to rebuild it. If a tree falls on your roof during a storm, your homeowners insurance pays for the repairs. If a delivery driver slips on your icy front steps and sues you, your homeowners insurance pays for your legal defense and any settlement or judgment up to your policy limit.
The policy covers the structure of your home, your personal belongings inside it, additional living expenses if you must live elsewhere during repairs, and your personal liability for injuries and property damage to others. The policy has a deductible, typically $500 to $2,500, which you pay before the insurance company pays the rest. The policy has coverage limits for each category, and you choose those limits when you purchase the policy.
Homeowners insurance is required by nearly every mortgage lender. The lender requires it because the property is the collateral for the loan. If the house burns down and there is no insurance, the lender’s collateral is worth zero. The lender requires you to name the lender as the mortgagee on the policy so the lender receives notice if you cancel the policy. The lender does not receive the insurance proceeds if you file a claim. You do. The insurance protects your asset. The lender benefits indirectly because the asset that secures the loan is repaired or rebuilt.
Homeowners insurance is purchased from a private insurance company. You shop for it, compare quotes, and select the coverage you want. The premium is typically paid annually or through an escrow account that your lender manages. The lender collects a portion of the annual premium with each mortgage payment and pays the insurance company when the premium is due.
Mortgage Insurance: What It Covers and Who It Protects
Mortgage insurance protects the lender against the risk that you will default on the loan. If you stop making payments and the lender forecloses, and the foreclosure sale does not generate enough money to repay the loan balance, mortgage insurance pays the lender the difference up to the policy limit. The policy pays the lender. It pays you nothing. You pay the premium. The lender receives the protection.
Mortgage insurance is required when your down payment is less than 20 percent of the purchase price. A borrower who puts down 5 percent has very little equity in the property. If property values decline and the borrower defaults, the lender may lose money because the foreclosure sale proceeds are less than the loan balance. Mortgage insurance covers that loss. It allows lenders to make loans to borrowers with small down payments by shifting the default risk to a mortgage insurer.
Mortgage insurance comes in two forms depending on the loan type. Private mortgage insurance, or PMI, applies to conventional loans that are not insured by the federal government. PMI is provided by private mortgage insurance companies. The premium is typically 0.5 to 1.5 percent of the loan amount per year, paid monthly as part of your mortgage payment. PMI can be canceled once your loan balance drops below 80 percent of the home’s current value, either through paying down the loan or through appreciation. Federal law requires automatic termination of PMI when the loan balance reaches 78 percent of the original purchase price.
Mortgage insurance premium, or MIP, applies to FHA loans insured by the Federal Housing Administration. MIP has two components: an upfront premium of 1.75 percent of the loan amount, typically financed into the loan, and an annual premium of 0.50 to 0.55 percent of the loan amount, paid monthly. MIP on most FHA loans cannot be canceled for the life of the loan if you put down less than 10 percent. The only way to eliminate MIP on those loans is to refinance into a conventional loan once you have enough equity.
USDA loans have a guarantee fee, and VA loans have a funding fee, both of which serve a similar purpose to mortgage insurance but are structured differently. The key point is the same: you pay for insurance that protects the lender, not you, and you pay it because your down payment was small enough that the lender considers the loan risky without it.
The Two Policies Side by Side
| Homeowners Insurance | Mortgage Insurance (PMI/MIP) | |
| Who it protects | You, the homeowner | The lender |
| Who pays the premium | You | You |
| What it covers | Damage to your home, personal property, and liability | Lender’s loss if you default and foreclosure proceeds are insufficient |
| When it is required | By nearly all mortgage lenders | When your down payment is less than 20% |
| Can it be canceled | No. Required for the life of the loan | PMI: yes, at 80% LTV. FHA MIP: often for the life of the loan |
| Who receives claim payments | You, or your contractor, or the injured party | The lender only. You receive nothing |
| Typical annual cost | $1,200–$2,500 depending on location and coverage | 0.5%–1.5% of loan amount ($1,500–$4,500 on a $300,000 loan) |
Do You Need Both Mortgage Insurance and Homeowners Insurance?
If you have a mortgage with a down payment of less than 20 percent, you need both. The lender requires homeowners insurance to protect the collateral against physical damage. The lender or the loan program requires mortgage insurance to protect the lender against default loss. You pay for both. Neither is optional. The homeowners insurance protects you indirectly by repairing your home after a loss. The mortgage insurance protects you indirectly by enabling you to buy the home with a smaller down payment than you would otherwise need. It does not protect you directly in any way.
If you put down 20 percent or more, you need homeowners insurance only. The lender does not require mortgage insurance because your equity is large enough that the lender can recover the loan balance through foreclosure even if property values decline moderately. If you pay off your mortgage entirely, you are not required to carry homeowners insurance by any lender, but you would be financially reckless to drop it. A paid-off house that burns down with no insurance is a total loss with no recovery.
Frequently Asked Questions
Do I need both mortgage insurance and homeowners insurance?
If your down payment is less than 20 percent, yes. Homeowners insurance protects the property against physical damage. Mortgage insurance protects the lender against your default. Both are required by the lender or the loan program. You pay the premiums for both. Homeowners insurance pays you if your house is damaged. Mortgage insurance pays the lender if you stop making payments and the foreclosure sale does not cover the loan balance.
What are the cons of mortgage insurance?
You pay the premium, but the policy protects the lender, not you. The premium increases your monthly payment by hundreds of dollars. PMI on a conventional loan can take years to cancel, and FHA MIP often lasts for the life of the loan. The money you spend on mortgage insurance premiums does not build equity, does not reduce your loan balance, and does not provide any benefit to you beyond enabling you to buy the home with a smaller down payment. It is a cost of low-equity borrowing, not an investment in your property.
What is the difference between MIP and PMI?
PMI is private mortgage insurance for conventional loans. MIP is the mortgage insurance premium for FHA loans. PMI can be canceled when your loan-to-value ratio reaches 80 percent. MIP on most FHA loans with less than 10 percent down cannot be canceled and lasts for the life of the loan. PMI premiums vary based on your credit score and down payment. MIP premiums are set by HUD and are the same for all borrowers regardless of credit score. You do not pay both. You pay PMI if you have a conventional loan and MIP if you have an FHA loan.
How much is mortgage insurance on a $300,000 home?
For a conventional loan with 5 percent down, PMI typically costs 0.5 to 1.0 percent of the loan amount annually, which is $1,425 to $2,850 per year, or $119 to $238 per month, on a $285,000 loan. For an FHA loan with 3.5 percent down, the upfront MIP is 1.75 percent of the loan amount, or $5,064, plus an annual MIP of 0.55 percent, or $1,591 per year, or $133 per month. The actual premium depends on your credit score, your down payment, and the specific mortgage insurer’s rates.
How do I get rid of PMI?
Request cancellation in writing when your loan balance drops to 80 percent of the home’s original purchase price, or earlier if the home’s value has increased and you can document it with an appraisal. Federal law requires automatic termination when the balance reaches 78 percent of the original purchase price, provided you are current on your payments. For FHA loans, MIP cannot be canceled on most loans with less than 10 percent down. The only way to eliminate FHA MIP is to refinance into a conventional loan once you have at least 20 percent equity.
The Short Version
Homeowners insurance protects you. If your house burns down, it pays to rebuild it. If someone gets hurt on your property, it pays for their medical bills and your legal defense. You choose the coverage. You receive the claim payment. The lender requires it, but you benefit from it.
Mortgage insurance protects your lender. If you default and the foreclosure sale does not cover your loan balance, it pays the lender the difference. You pay the premium. The lender receives the protection. You benefit only indirectly, because mortgage insurance is what allowed you to buy the home with a small down payment in the first place.
Both insurance policies appear on your closing documents. Both add to your monthly payment. Only one of them has your name on it as the insured. That is the one you hope you never need to use, and the one you will be grateful for if you ever do.
