What Is Mortgage Life Insurance and how does it work? Mortgage Insurance (also known as mortgage guarantee and home-loan insurance) is an insurance policy which compensates lenders or investors for losses due to the default of a mortgage loan. Mortgage insurance can be either public or private depending upon the insurer. The policy is also known as a mortgage indemnity guarantee (MIG), particularly in the UK.
What Is Mortgage Life Insurance? (Explained)
Mortgage life insurance is typically bought to cover a mortgage, so in the event of your death your loved ones can pay off your outstanding mortgage. You may have also heard it called decreasing term life insurance.
The amount you are covered for decreases over the term of your policy, similar to the way a repayment mortgage decreases. Typically, mortgage life insurance is cheaper than a level term policy but you can get quotes for both and decide which best suits your needs.
When you buy a house your mortgage lender may attempt to sell you life cover. You’re under no obligation to buy from them, so take the time to compare life insurance quotes and find a policy that best suits you.
Mortgage Insurance: Important to Know
Let’s take a closer look at a few mortgage insurance specifics below:.
- The mortgage insurance coverage amount with a lender declines as your mortgage balance declines. The coverage amount on a separate policy remains the same, even as your mortgage shrinks.
- Mortgage insurance through a lender is not portable. An individual mortgage insurance policy through an insurance company is owned by you – you can keep it if you switch banks, pay off your mortgage or move to a new home.
- Mortgage insurance through a lender only pays out a benefit equal to the mortgage, even if both spouses die. Individual policies will pay out twice the amount in the event of a simultaneous death.
- A mortgage lender’s insurance names the bank as beneficiary if you die. A separate policy allows you to choose your own beneficiary.
- Mortgage insurance through a lender is not convertible to a permanent insurance policy. An individual term policy through an insurance company is convertible without a medical to a permanent policy – providing lifetime protection and the ability to generate a tax-sheltered cash value.
How does Mortgage Life Insurance work?
A decreasing term policy is usually used to cover the outstanding balance of a repayment mortgage.
With a repayment mortgage your debt decreases with each repayment you make. As your outstanding debt goes down, you may find that the amount of life cover you need will also decrease.
Decreasing term life insurance aims to cater for this, and so the total amount of cover decreases over time, roughly in line with your mortgage.
If you’re taking out a decreasing term policy to cover your mortgage debt, you should make sure that the term of your policy covers the length of your mortgage – e.g. 25 years.
The amount you’re covered for decreases over the policy term, but the monthly premiums remain the same.
If you were to die in the second year of the policy term, your payout would be significantly higher than if you died in the 20th year, as you would owe more to your mortgage lender.
Other factors being equal, a mortgage life insurance policy tends to have lower premiums than other policy types.
Is Mortgage Life Insurance Worth It?
Understanding the features and benefits of mortgage life insurance can help you make a smart decision about whether it meets your needs.
There are two main benefits to mortgage life insurance:
- A free and clear mortgage. In the event of your death, mortgage life insurance is designed to pay the balance of your home loan to the bank.
- Minimal underwriting. Typically, mortgage life insurance requires very little underwriting. This means that there is often no medical exam or blood work required in order to qualify for a policy. This can be a desirable feature if you have major health concerns that may have excluded you from obtaining a traditional life insurance policy in the past.
The disadvantages of mortgage life insurance
There are three primary disadvantages of mortgage life insurance:
- The payout isn’t fixed. Mortgage life insurance is typically referred to as a decreasing term life policy. As you repay your mortgage, the value of the policy also decreases. Unlike a regular life insurance policy, mortgage insurance can’t provide you with a fixed payout. So while you may start off with a $200,000 policy that benefit declines as your mortgage is gradually paid down.
- The policy payout goes directly to the bank. With this type of policy, it’s the lender who is the policy’s beneficiary – not your family. So when you die, the payout goes directly to the lender to repay the mortgage. Yes, your family benefits from having a mortgage-free home, but it won’t leave them with any cash for other outstanding debts and immediate living expenses – unlike a traditional life insurance policy.
- Premiums can be pricy compared to the coverage. In the beginning, the premiums you pay for mortgage life insurance may seem reasonable and in line with the coverage amount. However, as time goes by, you’ll actually be paying for less coverage (due to the policy being a decreasing term plan).
While you may like the idea of having mortgage protection, you may prefer having a more traditional life insurance policy. If so, you might consider traditional term life or first-to-die life insurance.
Often used for mortgage protection, these types of life insurance policies can ensure that your surviving spouse has the funds to pay off the mortgage, as well as any other expenses he or she may have.
How is it different from level term insurance?
There is another common type of term life cover called level term life insurance.
This policy is quite straightforward – it’s designed to pay out a flat sum if you die within the policy term. The payout is the same regardless of when it happens, and so premiums tend to be higher.
Points to consider with mortgage life cover
There are a few things to bear in mind when taking out this kind of policy. First of all, it may not be appropriate if you have an interest-only home loan, as the amount you owe the lender will not be falling year-on-year.
Many people decide to extend their mortgage term when they move house, or when they want to reduce the size of their monthly repayments.
It’s important to ensure that the length of the policy term always matches the term of the mortgage, so if your mortgage term changes for any reason, talk to your insurer about changing your life insurance policy.
Your mortgage lender may attempt to sell you life cover when you get your mortgage. You’re under no obligation to buy from them, so take the time to compare life insurance quotes and find a policy that best suits you.