Decoding Insurance Types: What First-Time Homebuyers Need to Know

Buying a home for the first time is a significant step and often one of the largest investments a person will make. Therefore, it is not only wise for borrowers to protect their investment, it’s also a requirement. One way to ensure protection is through a variety of insurance types. Each has a unique purpose and protects either the borrower, the lender, or the home. As borrowers move through the mortgage process, they will hear terms like hazard insurance, homeowners insurance, mortgage insurance, and title insurance.

Hazard Insurance

Typically, hazard insurance is part of a broader homeowners insurance policy. Hazard insurance protects the physical structure of the home from certain types of damage, such as fires, storms, and other natural events.

In the event of property damage caused by a disaster, hazard insurance can help cover the cost of repairs or renovation. Lenders may require buyers to have hazard insurance as a safeguard against  unexpected damage to the home’s structure.

Homeowners Insurance

Homeowners insurance is a comprehensive policy that combines various coverages to protect both the home and the owner’s belongings from a wide range of risks, including theft, damage to the structure, and liability for injuries that occur on the property. The minimum amount of coverage that lenders require depends on the replacement cost of the home or the unpaid balance of the mortgage. However, homeowners can choose to add the following optional coverages:

-Liability Coverage: Protects the homeowner if someone is injured on the property.

-Personal Property Coverage: Covers loss or damage of personal belongings, like furniture, electronics, or clothing, etc.

-Additional Living Expenses (ALE): If the home becomes uninhabitable, ALE coverage can help cover the costs of temporary accommodations.

Mortgage Insurance

Mortgage insurance is a type of insurance designed to protect the lender in case a borrower defaults on their home loan. While it doesn’t protect the borrower directly, it enables lenders to offer mortgages to borrowers who may not have a large down payment.

Requirements regarding mortgage insurance differ based on the type of loan program utilized. For loan programs that do not require traditional mortgage insurance, other fees may be required in order to offer similar protections. Here’s a quick overview of the types of mortgage insurance required by FHA, Conventional, USDA Rural Development (RD), and VA loan programs:

FHA loans (Federal Housing Administration) require Mortgage Insurance Premium. FHA borrowers must pay both an upfront mortgage insurance premium (UFMIP) and an annual MIP.

Upfront MIP (UFMIP) is a one-time premium, typically 1.75% of the loan amount, which can be paid at closing or rolled into the loan balance.

Annual MIP is paid monthly as part of the mortgage payment. It varies based on loan term, loan amount, and loan-to-value (LTV) ratio. MIP is generally required for the life of the loan if the down payment is less than 10%. For borrowers that put at least 10% down, MIP can be dropped after 11 years of on-time payments.

Conventional Loans require Private Mortgage Insurance (PMI) on loans with a down payment of less than 20% of the purchase price. PMI can be paid monthly, or as a one-time upfront premium, or as a combination of both. The cost depends on factors like credit score, down payment, and loan term.

PMI can typically be removed once the homeowner reaches 20% equity in the home or based on the loan reaching 78% of the original property value.

USDA RD Loans (U.S. Department of Agriculture Rural Development) don’t require traditional mortgage insurance but instead charge an upfront guarantee fee as well as an annual fee. The upfront guarantee fee, typically 1% of the loan amount, is a one-time charge that can be paid upfront or rolled into the loan. The annual fee, which is a percent of the remaining loan balance, is paid monthly and applies for the life of the loan.

VA Loans (U.S. Department of Veterans Affairs) charge a one-time funding fee. The fee allows the VA to offer loans without down payments or ongoing traditional mortgage insurance. This fee can range from 1.25% to 3.3% of the loan amount, depending on factors such as down payment size, first-time or repeat use, and military status. The fee can be rolled into the loan amount.

Some veterans, especially those with service-related disabilities, may be exempt from paying the VA funding fee.

Title Insurance

Title insurance protects against potential issues with the home’s title or ownership history. Before a home is purchased, a title search is conducted to ensure there are no legal claims, disputes, or unresolved ownership issues that could affect the purchase. Title insurance safeguards both the buyer and the lender against any surprises, such as past liens or ownership claims, that might surface after closing.

There are two main types of title insurance:

Lender’s Title Insurance: This is required by lenders and remains in effect until the mortgage is paid in full. Lender’s title insurance protects the lender’s financial interests by covering issues such as disputes in ownership, unpaid liens, back taxes, legal defense and settlement costs, and errors in public records.

Owner’s Title Insurance: While this insurance is optional for buyers, it is highly recommended. Owner’s title insurance provides protection against ownership disputes if someone else claims they have rights to the property, unpaid liens, debts left by previous owners, and issues like fraud, forgery, mistakes in historical documentation, clerical errors, and boundary disputes.

Owner’s title insurance provides long-term security by ensuring that a homeowner’s claim to the property is clear and legally sound. It is a one-time purchase that remains in effect for as long as the homeowner owns the property.

Summing It Up

Having a clear understanding of insurance and other aspects of home loan requirements helps borrowers better prepare for homeownership. While insurance is a key component to protecting a homeowner’s investment, working with an experienced MiMutual Mortgage Loan Officer is key to ensuring a mortgage process that is stress-free and tailored to meet a borrower’s needs.