Mortgage Insurance

Mortgage Life Insurance is a form of insurance specifically designed to protect a repayment mortgage. If the policyholder were to die while the mortgage life insurance was in force, the policy would pay out a capital sum that will be just sufficient to repay the outstanding mortgage.

Mortgage life insurance is supposed to protect the borrower’s ability to repay the mortgage for the lifetime of the mortgage. This is in contrast to Private mortgage insurance, which is meant to protect the lender against the risk of default on the part of the borrower.

The Mechanics

When the insurance commences, the value of the insurance coverage must equal the capital outstanding on the repayment mortgage and the policy’s termination date must be the same as the date scheduled for the final payment on the repayment mortgage. The insurance company then calculates the annual rate at which the insurance coverage should decrease in order to mirror the value of the capital outstanding on the repayment mortgage. Even if the client is behind on repayments, the insurance will normally adhere to its original schedule and will not keep up with the outstanding debt.

Some mortgage life insurance policies will also pay out if the policyholder is diagnosed with a terminal illness from which the policyholder is expected to die within 12 months of diagnosis. Insurance companies sometimes add other features into their mortgage life insurance policies to reflect conditions in their country’s domestic insurance market and their domestic tax regulations.

 The Controversy

Based on the mechanics of the product, mortgage life insurance is a financial product which paradoxically declines in value as the client-borrower pays more premium to the insurer. In many cases, traditional life insurance (whether term or permanent) can offer a better level of protection for considerably smaller premiums.

The biggest advantage of traditional life insurance over mortgage life insurance is that the former maintains its face value throughout the lifetime of the policy, whereas the latter promises to pay out an amount equal to the client’s outstanding mortgage debt at any point in time, which is inherently a decreasing sum. Hence, mortgage life insurance is extremely profitable for lenders and/or insurers and equally as disadvantageous to borrowers.

In addition, lending banks often incentivize borrowers to purchase mortgage life insurance in addition to their new mortgage by means that are on the verge of tied selling practices. Tied selling of a product of self or of an affiliated party, however, is illegal in most jurisdictions. In Canada, for example, this practice is explicitly forbidden by Section 459.1 of the Bank Act (1991).

Finally, mortgage life insurance is not required by law. It is up to the client-borrower whether he or she will opt to protect his or her property investment by an insurance product or not. Similarly, the choice of insurer is completely unrestrained as well.

Because of these suboptimal qualities of mortgage life insurance, the product has been subject to sharp criticism by financial experts and by the media across North America for over a decade. This has arguably led to fewer banks actively advertising this product in the recent years, although many still keep it in their portfolios. However, many critics fail to consider that in many cases where term life insurance is denied for health reasons, mortgage life insurance is still available. As such, mortgage life insurance can cover the biggest expense left by a deceased breadwinner – ie housing costs. Thus, it is simplistic to dismiss it out of hand as disadvantageous to borrowers.

Private Mortgage Insurance

The term Mortgage insurance may in some contexts refer to Private mortgage insurance (PMI), also known as Lenders mortgage insurance.[3] Private mortgage insurance protects the lender instead of the borrower, although its premiums are payable by the borrower. This type of insurance is compulsory in certain jurisdictions for mortgages started with low down payments.

In the United States, subject to Homeowners Protection Act of 1998, a borrower who provides less than 20% down payment up front may be required to pay for private mortgage insurance until the outstanding mortgage is less than 80% of the value of the property.

Your mortgage is likely to be your biggest monthly outgoing, so it makes sense to think about how any dependants would cover costs if you were to die unexpectedly.

Losing you is likely to be stressful enough, without them having to worry about losing the roof over their heads too. If you have dependants who rely on you to pay the mortgage each month, you should therefore consider mortgage life insurance.

This is a type of life insurance designed specifically to pay your mortgage in the event of your death, giving you peace of mind that your family or dependants will be able to afford to stay in your home, even if you are no longer there.

Different types of policy

There are three main kinds of mortgage life insurance, known as decreasing term, level term and whole of life mortgage life insurance. The right policy for you will depend on your individual circumstances and what sort of pay-out you are looking for in the event of your death.

Decreasing term mortgage life insurance

Decreasing term cover is a form of policy where the sum assured reduces in line with your mortgage debt. So, as you pay off what you owe, the amount which the insurer would pay out if you die also decreases.

For example, if in year one, your outstanding mortgage is £150,000, this is the sum that would be paid out to your beneficiaries if you die. If, in year 24, the outstanding sum is £1,000, this is how much your policy will pay if you die. Monthly premiums, however, remain the same throughout the term of the policy.

Remember that this type of policy is only really appropriate for people with repayment mortgages, who gradually pay off their mortgage capital over time. It will not be suitable for those with interest-only mortgages, who plan to pay off their mortgage capital at the end of the term, as the capital they owe remains the same until this point.

Level term mortgage life insurance

Level term life insurance is when the sum assured remains fixed for a set period of time. So, if you take out a policy for £150,000, that is the payout you will receive whether you die in the first year after taking out the plan, or in the last year.

This kind of policy can be particularly useful for anyone who wants to leave their dependants with a little bit extra when they die. Your mortgage debt will reduce over time, but as the payout remains the same, in the event of your death your loved ones may end up with some additional funds once the mortgage has been paid off. This can be used to cover any other expenses such as a car, school fees, bills and general living costs. Monthly premiums – which also remain fixed over the term of the policy – are, however, more expensive than for decreasing mortgage life insurance.

Whole of life insurance

Another option is to consider a whole of life insurance policy which will pay out whenever you die. Premiums – which are linked to investments – are more expensive than for level term mortgage life cover, so this is usually a less popular choice. It’s also worth bearing in mind that if investment growth is lower than expected, premiums can increase substantially over time.

Mortgage life insurance extras

Once you have decided on the right mortgage life insurance policy to suit your needs, you may want to consider adding other forms of financial protection to your policy. Statistically, we are more likely to suffer a serious illness than we are to die before the age of 65, so one of the most common forms of insurance added onto life insurance is critical illness cover.

This type of plan will pay out if you contract one of a list of serious medical conditions, ranging from a heart attack to cancer. Conditions covered can vary widely depending on which insurer you go to, so always make sure you read the small print carefully before buying so that you understand exactly what you are – and aren’t – covered for.

Remember that if you are taking out a combined life insurance and critical illness policy, you will only receive one payout on the event which happens first. That means if, for example, you contract a serious illness, the policy will pay out and then finish. It will not pay out again on your death.

Another extra that is often offered alongside life insurance is waiver of premium. This must be added at the start of your policy, whether it’s level term, decreasing term or whole of life cover.

It means that if you are unable to pay your premiums because you can’t work due to illness or injury, the insurer will continue to provide cover. However, usually you will still be responsible for maintaining your premiums for the first few weeks you are unable to work.

How will my mortgage life insurance quotes be calculated

When working out what premiums to charge you, insurers will look at the likelihood of you dying during your policy term. The sort of things they will take into consideration include your age, sex, health, occupation and weight.

Make sure you get several different quotes before buying cover, as premiums can vary widely from insurer to insurer.

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