Mortgage Life Insurance
(Everything you need to know - and more)
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If you recently purchased a home or are in the market for a new mortgage, there is a good chance that at some point, you will be offered a mortgage life insurance policy. Many people get confronted with this type of insurance and have no idea what it is or what it does, but it is actually a fairly straightforward type of insurance coverage.
Mortgage life and disability insurance is a basic life insurance policy that will pay off your mortgage if you die unexpectedly. Sound like a great idea? Hold on. There are some major downsides to this type of coverage, and you should definitely do your homework before buying it.
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Mortgage life insurance is also referred to as mortgage protection life insurance or even decreasing mortgage life insurance. Whatever it's called, mortgage life and disability insurance is a basic life insurance policy that will help pay off your mortgage when you pass away.
The bank that holds your mortgage is the beneficiary of the policy, and the death benefit will be paid directly to the bank to clear your mortgage.
Policy types and coverages can vary. A mortgage life and disability policy will not only pay off your mortgage if you die, it will also make your mortgage payments if you are disabled or lose your job.
It is important to note that many policies will only pay a disability benefit for a certain amount of time, often one or two years, and there may be a waiting period before these payments start.
In addition, this coverage only pays the mortgage principal and interest. You are still responsible for expenses such as HOA fees and your homeowners insurance premium.
It’s important to read your policy in full and understand the benefits and exclusions.
Mortgage Life Insurance is Not Private Mortgage Insurance
While mortgage life insurance is fairly simple, it is often confused with private mortgage insurance (PMI), which is a completely different product.
PMI is required by law if you make a down payment of less than 20% when purchasing a home. It lets home buyers purchase a house with a smaller down payment so they don't have to save up the full 20% that a mortgage lender will usually require.
PMI protects the lender from losing their investment if your home ends up in foreclosure.
Once you have reached 20% equity in your home, you can notify your lender (usually required in writing) that you no longer need PMI coverage.
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Mortgage Life Insurance Has Limitations
One of the biggest downsides to a mortgage life insurance policy is the number of exclusions. Because these policies are usually written on a guaranteed acceptance basis, which means they don’t require a physical or detailed health information, there may be some instances where you are not covered. It is extremely important to fully understand the exclusions of your policy.
Some mortgage life insurance policies will only pay a death benefit if you are killed in an accident, which means the policy will be of little help if you develop cancer or another disease that turns out to be fatal.
Another thing to consider is that a mortgage life insurance policy is often written as a decreasing term policy, so the death benefit decreases over time, (just as your mortgage payoff amount decreases as you pay your monthly mortgage payments), but the premium remains the same over the life of the policy.
Finally, some mortgage life insurance policies terminate if you refinance your house, rather than transferring to the new mortgage. This means you may have to choose between getting a better mortgage rate and losing the premiums you have already paid towards the policy. Look for mortgage life insurance polices that allow you to refinance.
Which is Better, Mortgage Life Insurance or a Term Policy
Term life insurance is another option when it comes to paying off your mortgage and in many cases it’s the better option.
Term life insurance is a simple life insurance policy. You choose a death benefit and pay a premium for a certain “term” and if you die during the “term” the insurer pays out the death benefit to your named beneficiary. Term life insurance is sold for specific lengths of time, common “terms” are between 10 to 30 years.
Once the term expires, the contract ends, you no longer need to pay the premiums and the insurer is no longer required to pay the death benefit. Term life insurance usually requires a medical exam.
The difference between term life and mortgage life comes down to 4 major factors:
- Beneficiary: Mortgage life insurance gives you no choice as to your beneficiary, your only option is the lender that holds your mortgage note. Term life insurance on the other hand lets you choose anyone to be your beneficiary. The money can go to pay off your mortgage but it can also go to your spouse, children or anyone else you wish to name.
- Price: In almost all cases, term life insurance, for the same amount of coverage will be cheaper. The cost difference can be as dramatic as 50 percent. Obviously, the price difference will vary depending on a number of factors. In general, if you are in decent health and don’t mind a physical exam, a term life policy will be cheaper.
It’s also important to remember that as you pay down your mortgage over time, the benefit of a mortgage life insurance is also declining (the policy only pays the off the balance left on your mortgage) but the premium remains the same. This is not the case with a term policy, the death benefit remains the same over the life of the policy, it never declines, making it a better value for your money. - Convenience: Mortgage life insurance is usually sold as a guaranteed acceptance product so you can’t be turned down for coverage and there is no medical exam. This makes it a very convenient insurance product if simply want your mortgage paid off if you die unexpectedly.
It is also an excellent product for someone who has health problems, is a big smoker, or has an addiction issue, basically any condition that makes it impossible, or extremely expensive to qualify for a term life insurance policy. - Flexibility: A mortgage life and disability insurance policy offers zero flexibility, it will simply pay off your mortgage upon your death. There is no way to use the money for anything else or even adjust the payout amount if you would like to leave some additional protection behind for your beneficiaries.
A term life insurance policy allows much more flexibility. You can choose the death benefit amount as well as the term, which you may choose to extend past your mortgage payoff. You may decide to purchase more coverage to not only pay off your mortgage but also fund your children’s college education
A term life insurance policy also gives your beneficiaries flexibility. Paying off the mortgage may not be their most pressing financial issue after your death, or it may make more sense to invest the money if you have a low interest mortgage. Term life lets your survivors decide what their most critical needs are and how to spend (or save) the money accordingly.
Unless you are in poor shape or have a medical condition that prevents you from qualifying for term life insurance, mortgage life insurance is usually a bad investment.
Term life almost always costs less, provides much more flexibility and gives your survivors true discretion as to how to spend the death benefit.
While term life is usually the better option, if you are unable to qualify for it, a mortgage protection life insurance policy can give your surviving family members peace of mind, knowing that your mortgage will be paid off if you happen to die unexpectedly.
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What to Look for in a Mortgage Life Insurance Policy
If you have decided to move forward and purchase a mortgage life insurance policy, here are a few things to consider:
- Shop Around: Just like any insurance product, there are lots of policies out there and finding the one with the best coverage at a reasonable price will take some legwork. Gather quotes yourself or let a Trusted Choice® independent agent do the research for you and present you with your best options.
- Watch the Exclusions: These policies are filled with exclusions, so make sure the policy doesn’t exclude death from an illness or only covers you if you are killed in an accident. Carefully review the exclusions section and if you feel the policy is too restrictive, keep looking.
- Is It Transferable?: Verify that the policy can be transferred if you refinance your home. As interest rates fluctuate you may want to redo your mortgage at some point. A policy that can be transferred to your new mortgage is always recommended.
- Check Financial Strength: There are many small insurance companies out there writing mortgage protection life insurance, so it pays to make sure they have the financial resources to cover any claims. You can investigate a company’s financial strength at A.M. Best Co.
An independent agent is ready to help you find the perfect policy for your needs, regardless of whether it is a mortgage life insurance policy or term life coverage. Get started today and contact an independent insurance agent.