Homeowners would like some clarification on the difference between PMI and mortgage life insurance

Q: We bought our home with less than 20 percent down. The result is that we have been required to finance with private mortgage insurance (PMI). What is the difference between PMI and mortgage life insurance?

A: Homes are large assets, and it follows that you can find many insurance products associated with residential real estate.

Private mortgage insurance — generally known as PMI — comes into play when you want to finance or refinance property, and the loan-to-value ratio is less than 80%. For instance, if you buy a property for $300,000 and put down $15,000, you have a loan with 5% down. This makes lenders very uncomfortable.

They want you to share more of the risk. They want you to pay 20% upfront.

The good news is that you can readily buy or refinance without 20% upfront. This is done every day by borrowers who finance with backing from such federal programs as the FHA (as little as 3.5% down), VA (0% down) and USDA (0% down) programs. PMI is simply a private-sector form of mortgage insurance.

With mortgage insurance, the borrower pays a premium in exchange for coverage. If something goes wrong, the insurance company steps in and pays the mortgage lender some or all of the money lost.

Mortgage life insurance is different. Lenders do not require it. Instead, it pays benefits if you die or have a terminal, chronic or critical illness. As with all insurance coverage, you need to investigate what such terms really mean.

Mortgage life insurance traditionally pays off the lender in the event of a claim. Since the size of the mortgage balance drops with every payment, it follows that the amount of coverage also declines. Alternatively, some mortgage life insurance policies have a set value and pay benefits directly to policyholders. It is then up to the policyholders to determine how the money should be spent.

You may find that mortgage life insurance is available without a physical. This is a red flag. If a physical is not needed to get health insurance coverage, then it might attract people with serious illnesses and conditions. If you’re healthy, it means you may be paying very high premiums that do not reward your good physical condition.

Another red flag is the willingness to return premiums if there has been no claim. Sounds enticing. Let’s say you get mortgage life insurance and pay premiums for 25 years. You have no claim. The insurance company sends you a check equal to all premiums paid. Just be aware that times change, and inflation can substantially erode the buying power of your dollars.

As an alternative to mortgage life insurance, speak with insurance brokers regarding other forms of coverage. What is the cost for the same amount of coverage? Does the coverage amount decline over time? Who gets the money in the event of a claim? And certainly — if you’re in good health — consider policies that require a checkup.