Home Insurance: Why It's Part Of Your Mortgage

When you take out a mortgage, your lender will require you to purchase homeowners insurance to protect their investment. This is because if your house is uninsured and it burns down, you will not be able to pay your mortgage anymore. If home insurance is not included and the house is destroyed, your lender would lose their money if you defaulted on your loan. Therefore, homeowners insurance is included in your mortgage payments if you have an escrow account, as most lenders require. Your escrow is where you send payments for your mortgage, property taxes and insurance.

Escrow accounts

When you buy a home, your purchase agreement will usually include a good faith deposit to show the seller that you are serious about the purchase. This deposit is protected by an escrow account, which ensures that the money goes to the right party according to the conditions of the sale. If the contract falls through due to the buyer's fault, the seller usually keeps the money. If the purchase is successful, the deposit is applied to the buyer's down payment.

After you purchase a home, your mortgage lender will typically establish an escrow account to pay for your taxes and homeowners insurance. Each month, your mortgage servicer takes a portion of your monthly mortgage payment and deposits it into the escrow account. When your tax and insurance payments are due, the funds are released from the escrow account to cover these expenses.

Having an escrow account ensures that your homeowners insurance premiums and real estate taxes are paid on time. It also protects the lender's investment in your home. If your tax bills don't get paid, the tax authority could put a lien on your home, which could cost the lender money if the tax authority chooses to foreclose. If your homeowners insurance lapses, significant damage to or loss of the home could lead to an extreme loss of value.

While escrow accounts offer peace of mind and convenience, they can also result in higher monthly mortgage payments. Additionally, the amount required for escrow can vary from year to year, as tax bills and insurance premiums can change. Lenders or servicers will typically analyse escrow accounts annually to ensure they are collecting the correct amount.

Home insurance is separate from mortgage insurance

Home Insurance:

Home insurance, also known as homeowners insurance, is a type of property insurance that covers the structure of your home and its contents. It provides financial protection in the event of damage or loss caused by unforeseen events, such as fires, storms, or other disasters listed in the policy. Home insurance also includes liability coverage, which protects you if someone is injured on your property. This type of insurance is typically required by mortgage lenders to protect their investment in the property. However, even after the mortgage is paid off, it is recommended to maintain home insurance to safeguard your investment in your home.

Mortgage Insurance:

Mortgage insurance, often referred to as private mortgage insurance (PMI), serves a different purpose. It is designed to protect the lender or mortgage lender in case the homeowner defaults on their loan and is unable to make mortgage payments. Mortgage insurance is typically required when the down payment on a home is less than 20% of the purchase price. It can be paid in a lump sum upfront or through monthly payments, and it may be included in the monthly mortgage payment. However, it is important to note that mortgage insurance does not cover the home or protect the homebuyer; it solely safeguards the lender's interests.

Key Differences:

The main distinction between home insurance and mortgage insurance lies in whom they protect. Home insurance safeguards both the homeowner and the lender by covering the structure, contents, and liability. On the other hand, mortgage insurance exclusively safeguards the lender's investment in the event of the homeowner's inability to make payments. Additionally, the requirement for home insurance is tied to the value of the home, whereas mortgage insurance depends on the down payment amount.

In summary, while both types of insurance are important in the home-buying process, they serve distinct purposes. Home insurance protects your home and its contents, while mortgage insurance protects the lender's financial interests. Understanding this difference is crucial when navigating the complexities of purchasing a home and securing the necessary insurance coverage.

Home insurance protects your possessions

Home insurance is a requirement for anyone who takes out a mortgage loan to buy a house. It is necessary to protect the lender's investment, and also to protect you and your possessions.

Home insurance covers the structure of your home and pays to repair or rebuild it in the event of a disaster, such as a fire, hurricane, or lightning strike. It also covers your possessions, including furniture, clothing, sports equipment, and other personal items, if they are stolen or destroyed by an insured disaster. This coverage is usually 50-70% of the insurance you have on the structure of the house. It's important to note that home insurance typically doesn't cover damage caused by a flood, earthquake, or routine wear and tear.

Personal possessions insurance is an optional extra that can be added to a standard home insurance policy. This covers items worth less than a certain amount, typically £1,000, against theft or damage when they are away from home. This can include mobile phones, cameras, jewellery, watches, laptops, and sports equipment.

Some home insurance policies also include cover for students living away from home, insuring their possessions in student accommodation. This can be particularly useful for parents who want to ensure their children's possessions are protected while they are at university.

Mortgage insurance protects the lender

Mortgage insurance, also known as private mortgage insurance (PMI), is an insurance policy that protects the lender in the event that the borrower defaults on their payments. It is important to note that mortgage insurance does not cover the home or protect the homebuyer; instead, it acts as a safeguard for the lender, ensuring they do not suffer losses if the borrower becomes unable to make payments. This type of insurance is typically required when the borrower's down payment is less than 20% of the purchase amount, although this requirement can vary depending on the lender and loan product.

Mortgage insurance can be paid for in two ways: as a lump sum upfront or through monthly payments over time. In some cases, the monthly cost of the PMI premium may be included in the borrower's monthly mortgage payment, allowing them to make a single payment that covers both the mortgage loan and the insurance. This arrangement can provide convenience and ensure timely payment of the insurance premium.

It is worth mentioning that mortgage insurance is not the same as homeowners insurance. While mortgage insurance protects the lender, homeowners insurance safeguards the home itself, its contents, and the homeowner. Homeowners insurance is typically required by lenders for all borrowers, regardless of the down payment amount, as it protects their investment in the property.

Mortgage insurance plays a crucial role in helping borrowers qualify for loans they might not otherwise obtain. By lowering the risk to the lender, mortgage insurance enables borrowers with smaller down payments to access financing. However, it is important to understand that this added protection comes at an additional cost, increasing the overall expense of the loan.

In summary, mortgage insurance acts as a safeguard for lenders, ensuring they remain protected even if the borrower defaults on their loan. This protection allows lenders to extend financing to a wider range of borrowers, facilitating greater access to homeownership.

Home insurance is required by lenders

Home insurance is typically required by lenders to protect their investment in your property. This is because the home acts as collateral on a mortgage, meaning that the home guarantees the loan. If a homeowner defaults on their payments, the lender can seize the property and sell it to recover the money for the unpaid loan balance.

Lenders will therefore require proof of insurance before closing on a home loan. They will also require that the insurance covers hazards like fire, wind, hail, and vandalism, and that the coverage limit is high enough to fully replace the home in the event it is destroyed. This is known as the "scope of coverage" requirement.

If you drop your insurance, your lender will be notified and may buy far more expensive insurance on your behalf, known as "force-placed coverage". Alternatively, they could send the loan into default, which could result in foreclosure.

In addition to home insurance, lenders may also require borrowers to purchase mortgage insurance, also known as private mortgage insurance or PMI. This protects the lender in case the borrower is unable to make payments and is usually required when the down payment is less than 20% of the purchase amount.

Frequently asked questions