3 types of insurance lenders require, and potential add-ons
Insurance requirements for a mortgage
- Most borrowers must carry mortgage insurance until they build 20 percent equity in their homes.
- Title insurance protects the borrower and lender if a previous claim on the property surfaces.
- Homeowners insurance provides coverage for property damage or certain injuries.
- Lenders may require additional types of insurance, depending on the home and location.
When you purchase a home, you’re not only buying an asset but assuming responsibility for its past, present and future for as long as you own it. If you took out a mortgage, you are also accountable for your lender’s investment until you pay it off.
There are several types of insurance to help protect you in the event that you are held liable for any issues with your property or mortgage after you buy. Lenders will require that you purchase this insurance to cover their stake in your home. They include — but aren’t limited to — mortgage insurance, homeowner’s insurance and title insurance.
Mortgage insurance protects your lender should you default on your loan. Lenders that issue conventional loans consider borrowers at risk of default when their mortgage represents more than 80 percent of the home’s value. As such, private mortgage insurance (PMI) is required of borrowers who make down payments of less than 20 percent. PMI is typically a monthly expense, but in the case of conventional loans it can be canceled after the borrower builds sufficient equity in their home — by either paying down the mortgage or through property-value appreciation.
Homebuyers who obtain a government-backed mortgage through the U.S. Federal Housing Administration (FHA) must also pay a mortgage insurance premium (MIP) if they have less than 20 percent equity. FHA mortgage insurance is paid yearly after an initial upfront payment, and unlike PMI is not eliminated when a certain amount of home equity is attained. MIP is typically paid over the entire life of the loan, or in certain circumstances for at least 11 years. It may be possible to eliminate MIP if the loan is refinanced.
Title insurance protects you against any unknown claims against your property, and is a one-time expense paid when you close your mortgage. There are two steps to title insurance: First, a comprehensive check of public records for any claims against your property by individuals, businesses, government or other entities. The second is issuance of an insurance policy that will cover any expenses should an unknown claim emerge in the future. Title insurance will either settle the dispute or reimburse you if the claim is found to be legitimate by a court.
There are two types of title insurance: mortgagee’s title insurance — which protects your lender — and owner’s title insurance, which protects you. While your lender will usually only require mortgagee’s insurance, it is wise to purchase an owner’s policy as well so that your investment in your home is fully compensated if a valid claim is made on the property.
Homeowners insurance is a monthly expense that is typically rolled into your mortgage payments via an escrow account, or paid as an annual premium. It is comprised of two elements: hazard insurance to protect the physical structure of your home, and liability insurance to protect you if someone is injured on your property and decides to sue for damages.
Homeowner’s insurance covers damage to your property from incidents such as fires, storms, theft and vandalism. Note, however, that the hazard component of homeowner’s insurance typically does not cover damage from natural disasters such as floods, hurricanes or earthquakes.
Bonus: Disaster insurance
Damages caused by major natural disasters are extremely costly for insurance companies to cover. As such, coverage for floods, hurricanes and earthquakes involves insurance policies that must be purchased separately from your homeowner’s insurance.
While any homeowner is eligible to purchase these additional policies, if you live in a floodplain or earthquake-prone area, your lender may require that you buy corresponding insurance. Earthquake insurance is often a buy-up that can be added to your homeowner’s insurance, while most flood insurance is issued through the Federal Emergency Management Agency’s National Flood Insurance Program.
Don’t forget that on top of these insurance costs, your local community will be expecting you to pay property taxes. Depending on your lender and loan, property taxes may be tied into your monthly mortgage payments via an escrow account. Make sure to carefully calculate how much house you can afford to ensure that you are able to manage all of the expenses that come with your new property.