What Is Mortgage Life Insurance?Find out about mortgage life insurance, its pros and cons, and how it compares to other insurance policies.
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Buying a house can be an exciting step in your life. However, it can often be met with some hard decisions and unexpected costs.
One of these is deciding whether to get mortgage life insurance, which is an insurance policy that pays your mortgage debt if you die.
In this article, we will discuss mortgage life insurance, what it covers, its alternatives, as well as everything you need to know about the policy.
Terms You Should Know:
Beneficiary: A nominated person who will receive the full, or a portion of, a life insurance contract’s death benefit.
Death Benefit: The amount of money that will be paid out to a policyholder’s beneficiaries when they die.
Policyholder: The person who is insured by a life insurance contract.
Premium: A recurring payment for your life insurance to receive continued coverage.
Mortgage Life Insurance: What Is It?
A mortgage life insurance policy is a type of term life insurance that is meant to pay off a borrower's mortgage debts and associated charges if the borrower dies.
What Is Term Life Insurance?
Term life insurance policies are contracts between policyholders and insurance companies that financially cover people in the event of their death within a specific period or length of time.
Policyholders pay the insurance company a monthly premium and when the policyholder dies, the insurance company pays out a death benefit. However, once the term or period ends, their coverage will be over.
The other type of life insurance you can buy is permanent life insurance, which only ends when a policyholder dies or if they stop paying their premiums.
A mortgage life insurance policy differs from traditional life insurance policies in a number of ways.
With a mortgage life insurance policy, the payout is only made when the borrower dies while the mortgage hasn’t been paid.
The beneficiary is not a spouse or family member, but rather the mortgage lender.
If you die, the insurer will pay the outstanding sum on your mortgage to your lender. This type of life insurance does not provide money to your family.
The period, or term, that your mortgage life insurance policy lasts, will match the number of years you have to pay off your mortgage.
The death benefit for this policy is typically reduced each year in line with the changing and outstanding mortgage balance.
How Does Mortgage Life Insurance Work?
Mortgage life insurance is usually sold by mortgage lenders, who are often affiliated with insurance companies.
Let’s take a look at the two types of mortgage life insurance you can get.
Decreasing Term Insurance
This type of mortgage insurance policy’s cover decreases along with the outstanding mortgage balance until they both reach zero.
With decreasing term insurance, your coverage amount matches the amount your mortgage costs. This sum will then reduce each year for the length of the policy, eventually finishing at zero.
In return for this cover, you pay a monthly premium to the insurance company. The premium itself does not decrease. It is set at a certain amount to reflect the overall cost of the policy from start to finish, and it then stays the same for the duration of the policy.
This insurance option reduces the coverage amount in line with the outstanding debt that you want to pay off. In this case, your mortgage.
Because of this, it is a cheaper policy compared to one where the amount of cover remains constant throughout the term.
Level Term Insurance
In this case, the size of the policy remains constant throughout. This type of mortgage life insurance would be ideal for a borrower with an interest-only mortgage.
Level term life insurance pays out a pre-agreed fixed lump sum to your dependents (spouse, children, or grandparents) if you die within the term of the policy, whereas with decreasing term insurance the payout decreases throughout the policy’s term.
If you want to ensure that your family can pay for day-to-day living expenses and household expenditures, level term insurance may be the best option. Decreasing term insurance may be better if you simply need enough coverage to pay off a debt.A Comparison of Decreasing Term Life and Level Term Life Insurance
|Decreasing Term Life Insurance||Level Term Life Insurance|
|Payments stay the same for the term of your policy unless you change it.||Payments stay the same for the term of your policy unless you change it.|
|Because it's designed to insure the payment of your mortgage, the amount of insurance reduces in line with the mortgage payments made.||There is a fixed amount of insurance, agreed upon when the policy is taken out.|
|This option may be ideal for those who wish to ensure that their mortgage is paid off if they die while the insurance is active.||If you die during the term of the policy, your family will receive a lump sum payout that can be used to cover everyday living expenses, childcare costs, or help pay the mortgage.|
|This option could be perfect for those who want to help make sure their loved ones are financially secure.|
Terms You Should Know
An interest-only mortgage is a type of mortgage in which the borrower (or mortgagor) is required to pay only the interest on the loan for a certain period.
Most interest-only mortgages require interest payments for a specified time period, typically five, seven, or 10 years.
After that, the loan converts to a standard schedule where the borrower’s payments will increase to include both interest and a portion of the mortgage principal.
The principal is repaid either in a lump sum at a specified date, or in subsequent payments.
What Is The Principle?
Your mortgage principal is the amount you borrow from a lender to buy your home. For example, if your lender gives you $250,000, your mortgage principal is $250,000.
Advantages of Mortgage Life Insurance
The biggest advantage of taking out a mortgage life insurance policy is that it doesn’t require extensive underwriting.
What Is Underwriting
Underwriting is the process that an insurance company uses to decide whether to accept or deny insurance coverage.
This means there are no medical exams or tests required for the policy. This is an ideal option for potential homeowners with serious pre-existing medical conditions, which would prevent them from buying traditional life insurance.
Other mortgage life insurance advantages include:
Security of home:
Your spouse and children won't have to worry about what might happen to the family home if a mortgage life insurance policy is in place.
The mortgage life insurance policy will not only pay off the entire mortgage loan if the policyholder dies, but also if they become extremely ill and unable to work.
The policyholder’s family can rest assured that they will always have a place to live with the mortgage paid off, as long as they can afford the property taxes and insurance each year.
Most mortgage life insurance policies have a disability or accidental injury rider that offers additional coverage.
An insurance rider is an extra form of coverage that people can add to their policies.
These can be extremely useful if a policyholder becomes disabled or is unable to work.
Mortgage life insurance includes both of these benefits within its coverage, while most other traditional life insurance plans do not.
Mortgage life insurance is therefore a bit more versatile than a traditional term or whole life policy.
Disadvantages of Mortgage Life Insurance
Even though there are a few benefits to purchasing mortgage life insurance, there are a few downsides to this policy type, too:
Expensive for individuals in good health:
Mortgage life insurance policies are often more expensive than term life insurance policies for the same amount of coverage since they do not consider your health.
If you are in good health, speak to a life insurance agent to find out if you can get the same amount of coverage for a lower monthly premium.
Lack of flexibility:
Initially, mortgage life insurance may seem like a great solution to protect your home against potential foreclosure or eviction.
Over time a family’s biggest financial needs may change. Their mortgage life insurance, however, will not grant them any flexibility or leeway, as the payment goes to the mortgage lender.
With a term life insurance payout, on the other hand, your beneficiaries receive the money and can use it however they want, including payment of:
Credit card debt
Ultimately, you should look at your financial situation and goals before you buy any type of insurance coverage. For some people, mortgage life insurance is the right solution but in other cases, you might be better off with term life insurance or final expense insurance.
What Is Final Expense Insurance?
Final expense insurance is a type of permanent life insurance.
While not aimed at providing a living for those left behind, its purpose is to provide coverage for end-of-life expenses like medical bills and funeral costs. This can cover things like a casket and hearse, a headstone, the cremation fees, and the cost of a service.
Final expense insurance has a lower death benefit and is designed for older adults who are ready to make end-of-life plans, typically aged 50 and older.
It may be purchased as a secondary policy to supplement benefits from other life insurance, or as a form of guaranteed issue coverage that doesn’t require a medical exam.
Choosing the Right Kind of Insurance
Although mortgage life insurance may seem like a good option when you first buy a house, there are other insurance plans that can offer you the same peace of mind.
For example, with a term life insurance policy, you can cover whatever amount is required to meet all of your family’s needs—not just mortgage payments.
Mortgage life insurance, on the other hand, is only designed to pay off your mortgage. With most mortgage life policies, the death benefit will decrease in line with the principal mortgage balance.
Some other advantages of term life insurance include:
Term life gives your family flexibility:
If you die within the policy's term, term life insurance pays a death benefit to any beneficiary you designate, such as your spouse or children.
Your beneficiaries are free to spend the funds as they see fit. They can use the money toward other pressing requirements if paying off the mortgage isn't a priority.
The death benefit of mortgage life insurance, on the other hand, usually goes to your lender rather than your family.
Term life coverage can extend past your mortgage term:
Many companies offer term life insurance with terms ranging from five to 30 years. Life insurance buyers have the option of choosing a term length and are not restricted to a set length.
A mortgage life insurance policy, on the other hand, is tied to the lifetime of your home loan.
Term Life Insurance vs. Mortgage Life Insurance: Which Is Best for You?
Term and mortgage life insurance policies have many similarities; however, term policies are typically more flexible and less expensive—especially if you are in good health and don’t smoke.
Here are some of the key differences between term life insurance and mortgage life insurance:
|Feature||Mortgage Life Insurance||Term life Insurance|
|Amount of coverage||Mortgage principal||Any amount|
|Length of coverage||Mortgage length||5-35 years|
|Beneficiary||Mortgage lender in most cases||Your choice (child, spouse, etc.)|
|Death benefit paid upon...||Your accidental death (this includes things like car accidents)||Your death|
|Underwriting||Health questions (often no medical exam)||Health questions and medical exam|
Other Mortgage-Related Insurance Policies
Aside from mortgage life insurance, you may hear about a few other plans when getting a mortgage.
These may be sold independently or as part of a package, but the terms of each are distinct:
Mortgage disability insurance:
Mortgage disability insurance—sometimes called mortgage payment protection insurance—is a type of insurance policy meant to cover some or all of your mortgage payments if you can't work due to illness or injury.
However, because it does not cover additional expenses, most people are better served by a long-term disability insurance policy, which provides more comprehensive coverage.
Mortgage disability insurance can be purchased separately or as part of a larger mortgage protection insurance policy (MPI).
Mortgage protection insurance (MPI) is a type of life insurance that only covers your mortgage if you die, whereas mortgage disability insurance pays your mortgage if you become handicapped.
Mortgage unemployment insurance:
Mortgage unemployment insurance will pay your mortgage if you are laid off or fired without cause.
If you lose your job, unemployment insurance steps in to make payments on your behalf so you don't have to do so.
Having unemployment protection can give peace of mind as well as protect your credit score, because it prevents you from missing payments.
Unemployment insurance, on the other hand, can be costly. On top of that, if you add insurance to your loan, you'll almost certainly have to pay interest on the insurance premium, raising the total cost of the loan.
The purpose of this policy is to keep your home out of foreclosure while you are looking for work.
Note, however, that if you quit or are fired for serious transgressions, then you may receive no payout from your mortgage unemployment insurance contract.
Private mortgage insurance (PMI):
A borrower may be forced to purchase private mortgage insurance (PMI) as a condition of getting a traditional mortgage loan. When a homebuyer makes a down payment of less than 20% of the home's purchase price, most lenders will require PMI.
This is because when a borrower makes a down payment of less than 20% of the property's value, the mortgage's loan-to-value (LTV) ratio is over 80%, and the higher the LTV ratio, the higher the risk profile of the mortgage for the lender.
Unlike most other types of insurance which cover the lender's investment in the home and not the person who bought it (the borrower), a PMI allows some people to become homeowners sooner.
PMI can get financing for those who put down between 5% and 19.99% of the purchase price of a home.
Where Can I Learn More about Life Insurance?
Mortgage life insurance could be a valuable financial decision in the early stages of buying a house. However, when compared to term life insurance you may want to rethink which policy you end up choosing.
Understanding what you are signing up for should be your first step in the process. If you don’t, you could be missing out on a better insurance policy or signing up for a policy that doesn’t give you the best overall coverage.
If you’re currently looking for mortgage insurance or are curious about which life insurance policy is best for you, get in touch with one of our professional consultants for tailored advice.