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Types of Mortgage Insurance Policies and How They Work

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Types of Mortgage Insurance Policies and How They Work

So, you’re ready to take the leap into homeownership and want to prepare in every way. You have saved for the downpayment, researched what you can afford, and even started to look at homes.  You know about home loans and mortgages and home inspections.

The one thing you need to learn more about is the many possible insurances you might need as you become a homeowner. Beyond a realtor, a mortgage broker, and a home inspector, you will need to get yourself a good insurance agent who can help you address your insurance needs in homeownership.

From private mortgage insurance or PMI to mortgage protection insurance life insurance, you’ll potentially have an assortment of insurance needs once you decide to buy a house.

Read on to learn about the different types of insurance you might need or want as a homeowner.

Private Mortgage Insurance (PMI)

Private mortgage insurance or PMI is a type of insurance placed on your home mortgage. It does insure you, though. Instead, it’s put in place by your mortgage lender, and you pay for it.

PMI insurance gets arranged for your mortgage loan by the lender for your conventional mortgage. The mortgage lender requires the PMI conventional mortgage coverage as a safeguard in case you default on your mortgage. Take note, though, this insurance doesn’t protect homeowners against foreclosure.

You would only need to get PMI insurance on a conventional mortgage loan, not one backed by the government.

Why Do Lenders Require Private Mortgage Insurance?

Not all conventional mortgages will require PMI coverage. So, why do lenders require private mortgage insurance on some loans? PMI is required by lenders when the homeowner is not putting down a 20% down payment on the home they are purchasing.

Lenders figure when you put down at least 20% on the home loan, you have enough of your own money invested that it reduces the associated risk.

So, when a homebuyer seeks a home loan and wants to get a conventional mortgage, they will also need to pay for PMI insurance if they don’t have a 20% down payment. If you are getting a government-backed loan like an FHA loan, the mortgage insurance protection or MIP is built into the type of loan.

What Is the Impact of PMI on Your Mortgage?

How much will PMI cost? How is it calculated? There are a few variables to answer this question.

First, PMI gets calculated as a percentage of the mortgage loan amount, not the home’s overall value. The home might be worth $200,000, yet the homeowner put a down payment of 15%. So, the PMI rate calculation is on $185,000.

There are a few ways PMI gets calculated, and part of it depends on the type of PMI coverage. There is annual PMI insurance. This gets recalculated each year. So, in the above scenario, the homebuyer might pay about 1% of the loan amount of $185,000 or $1,850 per year.

But with annual PMI, the amount gets recalculated each year, so as the balance of the loan goes down, so does the PMI cost.

Conventional PMI is calculated on the loan amount. Lenders will also look at your credit score and loan-to-value (LTV) ratio to calculate the PMI.

Many homeowners might opt to buy a home and can’t avoid the PMI costs because of their down payment. Yet, after they build some equity in the home or the home’s value increases, they will opt to refinance to get rid of the PMI and its associated costs.

Can Private Mortgage Insurance Be Avoided?

The way to avoid paying for PMI insurance involves the down payment when buying a house. For most lenders, if you can put together a 20% or more down payment, you will not be required to have PMI on your mortgage loan.

For many seeking to buy a home, they have to weigh whether paying for PMI is better or waiting longer to buy while working to save for a larger down payment.

How Could PMI Provide a Benefit for a Homeowner?

While ideally, you want to avoid having to pay PMI. It can be an additional cost on top of a mortgage already. Realistically, it can limit how much some homeowners can afford when buying a house.

On the flip side, how could PMI be a benefit for a homeowner? The truth is that for many people saving up 20% of the cost of a home can either be difficult or take a very long time.

The benefit of the PMI for a homebuyer is that it allows many to get a conventional mortgage much sooner without needing to have the 20% down payment in cash before buying.

Mortgage Insurance

Once a homeowner has a home, they want to do everything they can to keep it, even if they are no longer living. If you’re the main wage earner and pay the mortgage for your home, you might want to consider one of the types of mortgage insurance.

These insurance policies either pay your mortgage when you’re not able or pay off your mortgage should you die before paying it off. They offer great peace of mind for many homeowners who want to make sure their family never has to leave their home if they could no longer pay the mortgage themselves.

Let’s take a closer look at the two key types of mortgage insurances to consider.

Disability Insurance

The premise of mortgage disability insurance is that you get an insurance policy on the mortgage should you be unable to pay for your mortgage because of a disability.

Businesses are required to carry workers compensation insurance to protect their business and their workers in the event of an injury or death while on the job. This worker’s compensation would pay a worker’s medical expenses and partial lost wages while injured and out of work.

The premise of mortgage disability insurance is similar. If you are unable to pay your mortgage because of a disability that puts you out of work, either short or long term, the insurance pays your mortgage while you’re unable to do so.

Mortgage Protection Insurance

Mortgage protection insurance or MPI is similar in nature. It actually works similarly to term life insurance, except it specifically covers your mortgage. MPI would pay off the balance of your mortgage if you die. Unlike other life insurance policies, the payout amount doesn’t get paid to your heirs; instead, it gets paid straight to your mortgage company.

Many MPI policies are set up similarly to term life policies. Over time, you will pay less for the policy. Why? Because over time, your mortgage gets smaller. So, if you did die, the amount the insurance company would need to pay less to pay off the mortgage.

Why Consider You Should Consider Mortgage Insurance

Many people opt to get one or both of these types of mortgage insurance for peace of mind. Perhaps your family dynamic is that you have one sole wage earner paying the mortgage. If that person gets injured and unable to work or dies, the wages are gone.

Often wage earners want to protect their families and make sure they would never have to leave their family home because they could no longer afford to live there. The kind of coverage offers a sense of security that your family and the family home would always be protected and paid for if you could no longer do it.

Homeowners Insurance

Homeowners insurance is another type of necessary insurance you will need as a homeowner. Not only will you want it for the protection it provides, but you’ll also be required to have it if you have a mortgage. Your lender will want yearly proof that you have an active homeowners insurance policy in place.

There are several things that a homeowners policy covers. These include:

  • Destruction and damage to a home’s interior and exterior
  • Loss or theft of possessions
  • Personal liability for harm to others

When you purchase homeowners insurance, there are three types of insurance you could get. These policies have to do with how much coverage you actually get in the event of a problem on your property. The policies might cover actual cash value, replacement cost, and extended replacement cost/value.

The cost of your policy will depend on several factors. First, policies can vary greatly based on the amount of coverage and the deductible you opt to take. It can also vary greatly based on the insurance companies assessment of your risk. They will consider several factors related to risk.

One consideration will be the value of your home and its location. They will also consider the condition of the home and possible risk factors because of its condition. Finally, they will consider you as a homeowner. Have you had claims on a policy before? How often have you made claims? The more claims you have made, the higher you are as a risk, and the higher your premiums will be.

Coverage Under Your Homeowners Policy

There are a variety of ways you can customize your homeowner’s insurance policy.

Of course, you want to make sure that both the exterior and interior of your home are covered for potential damage from things like fire, hurricanes, lightning, vandalism, or other covered disasters. If your home experienced damage from one of these things, you would be covered for repairs or getting rebuilt depending on the extent of your damage.

Most homeowner’s policies do not cover natural disasters like hurricanes or earthquakes. You will need to add a special rider to your policy for coverage if you live in an area where you’re at risk for natural disasters.

Possessions inside your home, like clothing and furniture, would also be covered. If you have an extensive collection of jewelry or high-priced furniture, you may want an additional rider to cover the value of those items inside your home.

Part of your policy also covers personal liability. This protects you from things that might happen while someone is on your property. Perhaps someone slips and falls in your driveway, and their claim would get covered under the liability portion of your policy.

You can also get coverage under your policy for your living expenses should you be required to move out of your home. Perhaps there is a fire in your home. It would help if you moved out of the house while repairs are being completed. This policy would cover your additional living expenses because of the fire.

Levels of Coverage

As mentioned, there are levels of coverage available in your homeowner’s policy. This has to do with how much coverage you actually get in the event you need to make a claim. Let’s take a close look at your options.

Actual Cash Value

Actual cash value coverage covers the value of your house and its contents to replace. The caveat is that the value covered is after depreciation. So, the insurance company won’t pay what it costs to replace them. They will pay how much the things are worth after it’s depreciated.

Replacement Cost

With replacement cost coverage, you would get your home replaced and its belongings at what it would actually cost to replace them. The insurance company would not apply the depreciation like they would in actual cash value coverage.

Guaranteed or Extended Cost

Even if you have replacement cost coverage, most policies will have a limit for how much they will cover. There is no limit on the amount of coverage you can get from a claim with guaranteed or extended cost coverage.

Lender-Placed Insurance

Lender-placed insurance is a type of insurance again required by a lender. It goes by many variations in name, including:

  • Force-placed insurance
  • Creditor-placed
  • Lender-placed
  • Collateral protection insurance

This is a type of policy put on a home or property by a lender. It’s put in place because the homeowner’s policy was canceled, lapsed, or their current policy was not enough to cover the property.

Remember, a lender has a vested interest in the well-being of your property or home. They want to make sure that anything that would cause damage or disrepair; insurance funds would be in place to fix it.

If the homeowner doesn’t secure homeowners insurance, then the lender will do it instead.

The insurance, again, protects the interests of the lender and would not likely cover any of your personal items. Instead, it would cover the actual home structure or property.

Of course, the lender will pass on the cost of this insurance to you as the borrower. You should know this type of insurance is almost always more costly than if you got your own homeowners policy on the home or property. Homeowners really want to make every effort to avoid this type of policy and instead get their own coverage.

Owner’s Title Insurance

Part of the process of buying a home involves getting a mortgage. You can either work with a bank or go to a mortgage broker who will help to find you the best mortgage possible.

Once you have found a home and are arranging the financing, one thing you want to be prepared for is the closing costs. Closing costs are the fees and charges you pay to the mortgage company at the closing time.

You can sometimes opt to finance them into your mortgage. You could also negotiate with the seller asking them to cover part of the closing costs.

One part of the closing costs comes from title insurance. Title insurance is a type of insurance that you are required to get when financing a home. Title insurance is a policy that protects from any unknown liens or claims to the property that might not have shown up on the title search.

When you’re ready to buy a house, the lender will have the title company run a title search on the property. They want to be certain there are not any liens on the property from the seller. They also want to make sure there isn’t anyone who later will want to make a claim on the property, perhaps through inheritance, for example.

The mortgage company or bank will require what is called lender’s title insurance. This is paid for in the closing costs one time. The policy lasts for the entire time you own the home. The lender’s title insurance protects the lender against any claims once they have committed to the property.

The lender almost always requires lender’s title insurance as they want their interests protected. You can also get owner’s title insurance.

Why Should a Homebuyer Consider Owner’s Title Insurance?

It’s important to understand who is getting the coverage when you consider title insurance. If there is suddenly a claim on your home or property, the lender’s title insurance protects the lender’s interests. Ultimately, it doesn’t protect your interests as a homeowner.

The only way you can be assured that your own interests as a homeowner are protected is to get the owner’s title insurance. It covers against the same thing. The difference is who it protects.

Again, it’s worth noting you only pay for title insurance one time with closing costs. This is not the type of insurance that you pay yearly premiums on. But once you have it, you’re protected for the entire time you own the home if you opt to get the lender’s title insurance.

Answering Your Insurance Questions

You may still have some questions related to your home insurance needs. Let’s see if we can answer those questions here.

How Much Home Insurance Do I Need?

There is not a one size fits all answer for insurance needs. An experienced insurance agent can help you figure this out.

Basically, you will want to consider your home’s value and what it would cost to rebuild the home should there be a disaster or damage to your home. You will also want to consider your contents and the assets connected to the home, and their value.

Are There Limits for My Personal Belongings?

Yes, insurance policies have limits on personal belongings. If you have high-value items, like jewelry, for example, you would want to add a special rider to cover those items.

While it might be impossible to calculate the value of all of your belongings, insurance companies generally cover personal belongings for up to about half of the value of your home.

Are There Limits on My Liability Insurance Coverage?

Remember, liability coverage is part of your homeowner’s policy. It protects homeowners in case someone gets injured while on the property.

Most policies start at $100,000 of coverage. Most insurers will recommend you increase that coverage to between $300,000 and $500,000 in value. Additionally, you may decide to purchase an umbrella policy to purchase $1 million or more of additional insurance protection.

Are There Ways to Save Money on My Homeowner’s Insurance?

Most importantly, you want to make sure you have the coverage you need. It protects you and your home should something terrible happen.

Having said that, there are a couple of ways to save. First, you could opt for a higher deductible. This is the amount you would pay out of pocket when you make a claim on your policy.

The other option is to consider bundling your insurance. Many insurers offer policyholders discounts when they insure multiple things, like a car and a home, for example.

Insurance for Homeowners

As a homebuyer and then homeowner, you need to be aware of many different types of mortgage insurance policies. From home buyers with private mortgage insurance to homeowners insurance on your property and even life insurance to cover yourself, you need to be informed to make sure you’re protected.

Ultimately, you want to make sure the home you work so hard to buy and care for has protection in the event of something unexpected. You also want to protect your family and make sure they can always live in the family home.

Do you have insurance needs or questions about your policies? Want to get more insurance for your home or self? We can help. At LoPriore Insurance Agency, we offer comprehensive insurance coverage options for all your insurance needs. Contact us today to get a quote and discuss your insurance needs.

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