The Three Kinds of Insurance That Protect Real Estate

Protection #1: Mortgage Insurance

This type of insurance protects your lender, not you.

First-time home buyers, typically strapped for cash, want to buy their homes with as little cash as possible. But the lender knows through experience that the less you put down, the more likely you are to default. (Think about it: If you put down $100,000 to buy a $300,000 house, walking away means you lose your $100,000. But if you had put no money down, walking away costs you nothing. Thus, the more money you put down, the less likely you are to default.)

Therefore, if you put down less than 20% of the purchase price, your lender will require you to buy mortgage insurance. Known as PMI, Private Mortgage Insurance protects the lender in case you default. The cost, which is included in your monthly payment, is 0.65% of your original loan balance. Thus, if you borrow $100,000, you'll pay $54.17 per month ($650 annually). That's why it may make sense to make a down payment of 20%: Doing so will allow you to avoid this expense, which adds up to many thousands of dollars over the life of your loan.

How to Beat PMI -- Without Putting 20% Down

Some lenders now let homebuyers avoid PMI with as little as 5% down in exchange for a slight increase in the interest rate. Although this will translate into a somewhat higher mortgage payment, the payment will still be lower than if you were paying PMI. Also, remember that PMI payments are not tax deductible, but the extra interest you'd be paying is -- further reducing the net cost of this alternative.

The recent introduction of these new loan programs serve as evidence of the continuing evolution of the mortgage industry, and why you need to seek counsel from those who monitor the latest developments.

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Protection #2: Homeowner's Insurance

Homeowner's insurance protects you, not your lender.

If the home is damaged or destroyed, this coverage provides you the money you need to rebuild the home and replace its contents. Only a fool would own a home without such insurance, and indeed, your lender will require proof that you have it. You buy it from a property/casualty insurance agent (as opposed to a life/health agent). Some financial planners offer it as well.

Protection #3: Title Insurance

Title insurance comes in two parts, one to protect the lender and one to protect you. You must buy the part that protects the lender; It's your choice to buy the part that protects you.

Your property may have changed hands dozens of times over the past 400 years, especially if it's on the East coast. Who's to say the person selling you the property really owns it? It is quite possible that the deed (or title) is defective. If that's true, you might not own the property you think you bought.

Title insurance protects you from the catastrophe of losing your home because someone challenges the validity of the title in court. This is why lenders require that you buy a policy to protect them, and why I strongly recommend that you buy a second policy to protect yourself.

You order a title policy for the lender during the mortgage application process, and if you order a second policy for yourself at the same time, the additional cost is quite low. Unlike other kinds of insurance, you pay for title insurance only once -- at settlement -- and it protects you for as long as you own the property.

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