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| Private mortgage insurance for home buyers |
When buying a home, it feels like the costs really add up quickly. You’re faced with various fees and costs that could be tied to the mortgage – or simply being a homeowner in general. Whether it’s utilities, closing costs, or insurance – it’s almost hard to keep track and understand where the money is going and what it’s going to be used for.
So, what is the difference between mortgage insurance and homeowners insurance?
These two insurance terms are commonly confused by first time home buyers. There are two major differences based on who the insurance is intended to protect.
Homeowner’s Insurance Protects the Borrower
Homeowner’s insurance is necessary to financially protect you and your home against disasters. Homeowner’s insurance. Homeowner’s insurance is considered to be a package offering as it covers two major areas: property insurance and liability coverage. This means your liability and legal responsibility for any property damage or injuries (accidents) that happen on your property and damage to your property. Some plans may even cover damage caused by your household pets.
These plans are priced according to the many factors involved in their estimation such as location, coverage, and the amount of insurance the home would require, also known as the replacement cost.
Mortgage Insurance Protects the Lender
PMI stands for private mortgage insurance and it is essentially insurance written by a private company that is meant to protect the lender from losses in the event the borrower defaults on the mortgage. The premium for PMI is paid for by the borrower and is generally rolled into their monthly mortgage payment.
PMI is considered “private” because it is only available to private companies. Government agencies and public mortgage lenders are not eligible. Certain public programs, like some VA and FHA mortgage loans, have their own mortgage insurance that is managed internally and run quite differently. The major difference between mortgage insurance and PMI is that PMI can expire once your loan to value ratio has dropped below 80%, whereas mortgage insurance on some loan products never expires.
Why do Lenders Require Private Mortgage Insurance?
Your lender is usually guaranteeing you a pretty penny when they agree to your mortgage loan, so, if they do not receive at least 20% down upfront, it would be risky in the event the borrower defaults on their payment. Even if you have a great credit score, it’s not that they don’t trust you, it’s simply that every party in the transaction deserves to be protected.
For example, when you buy a new home your lender will compare your sales price to the amount of your down payment to determine your loan to value ratio. If you purchase a home for $300,000 and you put $30,000, your loan to value ratio is 90%. If your loan to value ratio is higher than 80%, most lenders and loan programs will require you to pay PMI.
Everyone involved in a real estate transaction wants to be protected, making both homeowners insurance and mortgage insurance two very important pieces of the process to understand. Your mortgage lender should be able to further explain the importance of both when you check out mortgage options.
