You don’t need to be an insurance expert when you set out to buy your first home, but it can be a challenge when you come across the terms “homeowners insurance” and “mortgage insurance” for the first time. As you learn about your insurance needs at this important new milestone in your life, it may help to know that there is a difference between homeowners insurance and mortgage insurance. Depending on many factors, not every home owner needs mortgage insurance, but to ensure their new home is sufficiently protected, homeowners insurance is usually a necessity.

As you start house hunting and explore the process of getting pre-qualified for mortgage loans, here’s a look at each type of insurance, why you would need it, what it can help cover and when you might buy it.

What Is Mortgage Insurance?

Mortgage insurance, also known as private mortgage insurance or PMI, is insurance that some lenders may require to protect their interests should you default on your loan. Mortgage insurance doesn’t cover the home or protect you as the homebuyer. Instead, PMI protects the lender in case you are unable to make payments.

When Is Mortgage Insurance Required?

Typically, you may be required to have mortgage insurance when you take out a mortgage loan and your down payment is less than 20 percent of the purchase amount. The requirement to have mortgage insurance varies by lender and loan product. However, depending on your circumstances, some lenders may allow you to forego PMI even if you make a smaller down payment. Consider asking your lender if PMI is required, and if so, if there are exceptions to their requirement for which you may qualify.

Is Mortgage Insurance Included in Your Mortgage?

Mortgage insurance isn't included in your mortgage loan. It is an insurance policy and separate from your mortgage. Typically, there are two ways you may pay for your mortgage insurance: in a lump sum upfront, or over time with monthly payments. That said, it’s not uncommon to have the monthly cost of your PMI premium rolled in with your monthly mortgage payment. This way you can make one monthly payment to cover both your mortgage loan and your mortgage insurance.

If you want to know whether a lender requires mortgage insurance, how you pay it, and how much it will cost, check the loan estimate¹ you get from a lender for details and ask questions. You can also do your own research by visiting an online resource such as the Consumer Financial Protection Bureau. You’ll want to look for information that explains the closing disclosures on your loan estimate to better understand what PMI may be required, and whether you’d pay premiums monthly, upfront or both.

The good news is, if you do need mortgage insurance, you may be able to cancel PMI after you make enough payments on your loan to reach more than 20 percent equity in your home. Check with your lender to find out when and how you can get out of PMI² when you no longer are required to have PMI.

What Is Homeowners Insurance?

Homeowners insurance, also known as home insurance, is coverage that is required by all mortgage lenders for all borrowers. Unlike the requirement to buy PMI, the requirement to buy homeowners insurance is not related to the amount of the down payment that you make on your home. It is tied to the value of your home and property.

When Is Homeowners Insurance Required?

Homeowners insurance typically is required for anyone who takes out a mortgage loan to buy a home. After you pay off your mortgage, you’ll probably want to continue to have a homeowners insurance policy. While your mortgage lender can no longer require you to carry home insurance after you pay off your mortgage, it’s up to you to protect your investment.

Is Homeowners Insurance Included in Your Mortgage?

Some homeowners may think their home insurance is included in their mortgage because they make a single monthly payment that covers both their homeowners insurance premium and their monthly mortgage payment. However, homeowners insurance is not included in your mortgage. It is an insurance policy separate from your mortgage loan agreement. Even when your loan and insurance costs are bundled into a single monthly payment, your homeowners insurance premium goes to your homeowners insurance company and your mortgage lender receives your mortgage payment.

Your mortgage lender may set up an escrow account³ from which to pay your homeowners insurance and property taxes. This helps to ensure that you have enough money to pay both important expenses on time. Typically, the bank collects that money as part of your monthly mortgage payment, places the funds in escrow and then makes a payment to your homeowners insurance company on your behalf every six months or every year.

Do I Need Homeowners Insurance After My Mortgage Is Paid Off?

You need homeowners property and liability insurance even after your mortgage is paid off if you want protection for your home. Homeowners property coverage can help protect against the potentially devastating costs to rebuild or replace your property after damaging events like fire, lightening and windstorms. Homeowners liability insurance can help protect you if a guest falls at your home and is injured.

Unlike PMI, homeowners insurance is unrelated to your mortgage except for the fact that mortgage lenders require it to protect their interest in the home.

While mortgage insurance protects the lender, homeowners insurance protects your home, the contents of your home and you as the homeowner. Once your mortgage is paid off, you have 100 percent equity in your home, so homeowners insurance may become even more crucial to your financial well-being.

Here are four reasons you need homeowners insurance after paying off your mortgage:

1. Homeowners insurance covers the structure of your home. Your homeowners insurance can help pay to repair or rebuild your home after a covered disaster or event such as a break-in, a lightning storm, a house fire, a tornado or a hurricane. Most policies also cover detached structures on the property, such as a storage shed, gazebo or guest house. If you don't have homeowners insurance and your home is damaged or destroyed, you would be responsible for covering the costs to repair, replace and rebuild.
      
2. Homeowners insurance protects your possessions. Remember that it's not just the structure of your home that needs to be covered. Your home is filled with possessions that could be costly to replace, including furniture, clothing, sports equipment and tools. Your homeowners insurance also may cover items outside your home, such as your mobile phone or a newly purchased holiday gift that gets stolen in a car break-in. Homeowners insurance may even cover the trees and shrubs in your yard.
      
3. Homeowners insurance can help cover your lodging, if your home becomes temporarily unlivable. It’s a good idea for your home insurance policy to include additional living expenses (ALE) coverage. This coverage can help pay for an Airbnb, hotel or other lodging while your home is uninhabitable due to a covered event. ALE also may cover the cost of meals while your home is being rebuilt.
      
4. Homeowners insurance can help protect you from liability claims. One important and often overlooked part of homeowners insurance is liability coverage. You may need protection in case a guest or visitor gets injured on your property. For example, a neighbor might slip on some ice on your walkway. Liability coverage can help pay medical bills and possibly even cover your attorney fees when someone makes a liability claim against you.

As you can see, both mortgage insurance and homeowners insurance play an important part in home ownership. Ready to learn more about homeowners insurance from Travelers? Contact your agent. Don’t have one? Find an agent now.

Sources:
¹https://www.consumerfinance.gov/owning-a-home/loan-estimate/
²https://www.consumerfinance.gov/ask-cfpb/when-can-i-remove-private-mortgage-insurance-pmi-from-my-loan-en-202/
³http://myhome.freddiemac.com/own/pay-pmi-insurance-taxes.html