There are a variety of particular reasons why you might want to purchase a life insurance policy, whether it’s to pay off a particular debt like a mortgage or to simply provide your family with the financial stability they’d struggle to regain if you passed away. Usually it’s a choice between term life insurance and whole life insurance. But what about Mortgage vs Life Insurance? where does mortgage insurance come into play? We talked to an expert to find out when it’s needed.
What is life insurance?
Put simply, a life insurance policy will pay out a sum of money to your dependents in the event of your death.
This can take various forms, with different levels and lengths of cover available and different forms of pay-out depending on your particular requirements.
If you’re taking out a life insurance policy to ensure your family’s ability to keep up with day-to-day expenses that you are currently responsible for then you might want to opt for whole of life cover or level term insurance.
Whole of life cover, or life assurance, will guarantee your dependents a pay out in the event of your death, whenever this may be.
Level term insurance will cover you for a set period, generally around 25 years, and will pay out a fixed sum on your death if you die during the policy term. Once the term is up you will no longer be protected.
Level term insurance tends to be cheaper than whole of life cover given the reduced risk of a claim being made.
If your policy is there in order to make sure that your children have enough money to get by when you are no longer around to provide it, you should think about writing your life insurance in trust.
This means that when you pass away, the value of the pay-out of your policy will go directly into a trust to be looked after by a trustee until the intended beneficiary (or beneficiaries) reach a certain age.
This has the added benefit of sidestepping inheritance tax and removes the need for potentially lengthy probate procedures.
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What is mortgage life insurance?
Given that in many households, mortgage repayments are the biggest regular expense, many people purchase life insurance in order to help the remaining family members maintain them.
The best option available for those opening up a life insurance policy is to purchase decreasing term insurance.
This kind of policy is designed specifically to help pay off debts with decreasing values such as repayment mortgages.
They work by having the pay-out decrease throughout the policy term according to the value of the remaining mortgage payments to be made.
So if you have a decreasing term life insurance policy open and you die during its third year when you have £100,000 left to pay off, then it will pay out that amount. If, however, you live longer and then pass away during the last year of the policy term when you only have £1,500 left to pay off, then the insurer will pay out £1,500.
Decreasing term policies are cheaper than level term policies because of the steadily decreasing pay-out.
How do mortgages work?
First, a mortgage is the debt you owe when you can’t pay the full price of a home or other property—it’s the difference between what you offer as a down payment and the purchase price. Usually, lending institutions advance the difference to the seller, who then receives the full sale price upon closing of the deal. Then you sit down with the lender to work out your repayment terms.
Mortgage vs Life Insurance
How does mortgage protection insurance compare to life insurance? We break it down here. The first thing you’ll notice, though, is that mortgage insurance protects the lender for debt, and life insurance protects the homeowner’s beneficiaries for debt.
|Mortgage protection insurance through the lender||Life insurance through a life insurance company or financial advisor|
|Homeowner||Protects mortgage lender against debt||Protects homeowner’s mortgage debt|
|Beneficiary||Payout for mortgage lender||Payout for beneficiary|
|Evaluating medical evidence of your risk as the life-insured||Minimal questions||More questions, and for high coverage amounts ($500,00-$1million+) and older homeowners you may be asked to take health tests|
|Decision on assuming the risk and paying the claim||Underwritten at time of claim, so you may find out coverage isn’t available||Underwritten at time of application, so decision to provide coverage is made at outset|
|Amount of coverage||Drops as mortgage drops||Can stay the same or be reduced, at the policy owner’s discretion|
|Portability||Coverage applies to the same home under the same terms with the same lender||Coverage can be moved to cover any home and regardless of changes to mortgage lender or terms of repayment|
|Renewal of coverage||Need to renew coverage with each renewal period and change of lender. May need to prove reasonable, good health. Cost of coverage per dollar increases in accordance with rates at that time||Premiums remain the same for the length of the term. Renewal rates are guaranteed at the outset, and no further evidence of insurability is required if you keep the same policy|
|Use of coverage||Pays back the lender for the outstanding mortgage||Payouts for any purpose, including mortgage|
|Terms||Ends either when mortgage is paid off or when you switch lenders—whichever occurs first||Ends when you reach a certain age with term life insurance or the policy owners full lifetime with whole life insurance (term can be converted to whole coverage if desired)|
|Cost||2.8% to 4.0% of their mortgage amount||Significantly less than mortgage insurance. Approx. $500 a year, depending on the policy|
Is mortgage insurance worth it?
A home is probably the biggest asset you’ll own, and a mortgage is one of the biggest debts you’ll take on in your lifetime to buy it.
“Mortgage debt in Canada stood at almost $1.63 trillion dollars in the third quarter of 2020, according to Statistics Canada,” says Wouters. “Life insurance can pay off the mortgage for pennies on the dollar when a breadwinner dies, and this can save many thousands—perhaps hundreds of thousands of dollars—in interest payments, too.”
You and your family can gain peace of mind in that they can continue to live in your home and in the same neighborhood you chose with their best interests in mind. If it’s worth it to buy a home, for many it’s worth the additional costs of insurance. Consider what would happen if a critical illness struck or the breadwinner suffered a disability. There’s coverage for that, which can cover the mortgage or mortgage payments for a period of time.
Mortgage default insurance may not be as important if you own a home that has risen substantially in value; in the event of your death, your family could downsize to another home and pay for it in full. “Don’t forget about moving expenses, and legal and registration fees, which can really add up,” says Wouters. “Consider all of these things should a critical illness or disability strike. The needs for cash and cash flow are still there.”
Here’s one more thing to think about: Does it make sense to use the money to pay off the entire mortgage right away? Not necessarily. “Perhaps your surviving family could have eliminated the mortgage by selling the house and moving to a smaller or less expensive home. Alternatively, they might prefer to use the life insurance proceeds for other purposes and continue making mortgage payments, avoiding early payoff penalties and not having to worry about other expenses. Those options are not available through typical mortgage insurance from a lender like a bank, trust company or credit union.”
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Is life insurance worth it?
Individually owned life insurance tends to be cheaper than mortgage insurance. In some cases, it’s significantly less expensive than mortgage protection insurance from a lender.
Plus, people often have other needs besides paying off a mortgage, like providing income for a surviving spouse, home maintenance, education for your kids—all of which life insurance can cover. “If you have plenty of other assets and investments that wouldn’t trigger any taxes on your death, your spouse is working and earns even more than you do, and your survivor would move to a less-expensive home if you passed away, then having extra life insurance may not be as important,” says Wouters. “A growing number of people in their 60s and 70s have a mortgage and no heirs, or have heirs to whom they don’t want to leave much. The house would be sold on death, and whatever is left after the mortgage and other expenses are covered goes to the heirs. For those people, life insurance may not be as important a consideration when looking at paying off the mortgage.”