Life Insurance: Getting Mortgage Covered

Mortgage life insurance is a type of insurance that pays out a lump sum to your dependants if you die before you finish paying your mortgage. This type of insurance is designed to ensure that your loved ones don't have to worry about paying the monthly mortgage repayments or be forced to sell the property to repay the amount still owed. There are two main types of mortgage cover: decreasing term, where the payout reduces in line with your mortgage balance, and level term, where the payout is a fixed lump sum. You can also add critical illness cover to your policy, which will pay out if you are diagnosed with a critical illness. When considering mortgage life insurance, it's important to shop around for quotes and ensure that the policy suits your individual circumstances.

Decreasing term life insurance

For example, a 30-year-old male non-smoker might pay a premium of $25 per month throughout the life of a 15-year $200,000 decreasing term policy, which is customized to parallel a mortgage amortization schedule.

Who is it for?

It is also suitable for those who want to take out debt but need life insurance to cover the money they want to borrow. Getting decreasing life insurance allows you to pay the bare minimum to get the coverage you need for any loans.

Advantages

• Your mortgage will be protected if you die, allowing your family to keep their home or other assets purchased with debt.
• It is a more affordable option than whole life or universal life insurance.
• It can be used to cover personal or business loans, allowing the business to keep running.
• It allows for a pure death benefit with no cash accumulation.
• It may be required by certain lenders to guarantee that the loan will be repaid if the borrower dies before the loan matures.

Disadvantages

• You end up paying the same price for less coverage as the term goes on, whereas with a level term, your premiums and coverage don't change.
• Your family or beneficiaries won't be able to use the death benefit to cover other expenses besides the specific loan it is tied to.
• The main drawback is the death benefit declining over time, which is why it costs less than standard term life or other policies.

Level term life insurance

Advantages

• Predictability: Level term life insurance provides predictability and stability, as the payout to your beneficiaries and the premiums you pay remain the same throughout the policy term. This makes it easier for you and your beneficiaries to plan and budget.
• Long-term planning: The fixed payout allows you to make long-term plans with a single dollar amount in mind.
• Budgeting: Since the benefits and premiums are level, budgeting can be easier. The amount you pay for coverage stays the same year over year, assuming you don't make any changes to your policy.
• Cost-effectiveness: Level term life insurance allows you to lock in a rate and coverage amount based on your current health. If you're young and healthy, you can get affordable coverage over a long period.

Disadvantages

• Health-linked premiums: Rates for level term life insurance are based on your current health, and not everyone is as healthy as they can be. If your health improves over the years, you may end up paying a level but inflated price for the entire policy term. In this case, an annually renewable policy for a shorter period might be a better option.
• Premiums may be higher: Level term life insurance premiums are typically higher than those for decreasing-term insurance because the payout remains the same.
• Coverage expiration: Unlike permanent life insurance, level term contracts have an end date, and you won't have coverage or death benefits once the policy expires.
• No cash value: Level term insurance contracts don't accumulate cash value, so there isn't an investment component to potentially grow the contract's worth.
• Renewal costs: Once the contract ends, you'll likely pay higher premiums for coverage because it will be recalculated based on your age and health at the time of renewal.
• Fixed coverage: While level term insurance offers predictability, if your financial situation changes, you may not have sufficient coverage and might need to purchase additional insurance.

Other factors to consider

When deciding if level term life insurance is right for you, consider the following:

• Budget: Level term coverage allows you to know the cost and death benefit upfront, making it easier to budget without worrying about unexpected increases.
• Age and health: Generally, the younger and healthier you are, the more affordable life insurance coverage will be. If you're young and healthy, locking in low premiums now may be advantageous.
• Financial responsibility: Your dependents and financial responsibilities play a role in determining your coverage. Level term insurance can be useful if you have a young family, as it provides financial support during critical years without paying for coverage longer than necessary.
• Financial goals: Review your financial strategy. If you're focused on minimizing costs while maximizing protection, level term insurance may align with your goals.

Critical illness cover

When deciding whether to take out critical illness cover, you should consider the following:

• Whether you already have some form of illness insurance, such as through a life insurance policy or your mortgage, which covers you in the event of a serious illness.
• The benefits your employer pays if you are unable to work due to illness or disability.
• Whether you have savings that you can use instead of insurance.
• The cost of premiums, which can be quite high, and the fact that you will not get any money back if you do not make a claim.
• Whether there are any exclusions in the policy. Critical illness insurance policies do not cover every type of illness, and for the illnesses that are covered, you usually have to be extremely ill or totally disabled before you can claim. Pre-existing conditions may also not be covered.

You can buy critical illness insurance from an independent financial adviser or directly from an insurance company, either through a comparison website or by contacting insurance advisers directly.

Single or joint policy

When deciding between a single or joint policy for mortgage life insurance, it's important to consider your personal circumstances and preferences. Here are some key points to keep in mind:

Single Policy

A single policy covers one person and pays out if the policyholder dies within the policy term, provided the premiums are paid. This option ensures that your beneficiaries receive two payouts if both policyholders pass away within the term. Additionally, if your relationship ends, each of you will remain covered. This type of policy allows for more flexibility, as you can list additional beneficiaries and change them as needed. However, having two single policies can sometimes be more expensive than a joint policy.

Joint Policy

A joint policy covers two people under one policy and is typically more affordable than two single policies. It is a good option if you have shared finances and significant shared financial commitments, such as a mortgage. The main advantage of a joint policy is that it can be used to pay off the mortgage when one person dies, ensuring that your loved ones have one less financial burden. However, a joint policy only pays out once, after the death of the first policyholder, and the cover then ends. If the surviving partner still needs life insurance, they will need to take out a new single policy, which may have higher premiums due to their increased age.

Factors to Consider

When deciding between a single or joint policy, consider the following:

• The level of cover each person needs
• The cost of both options
• Your relationship status and stability
• The option to list multiple beneficiaries
• The potential for two separate payouts

Putting your policy in trust

Putting your mortgage life insurance policy in trust is a good idea if you want to protect your payout from inheritance tax. Normally, if you die while your policy is running, the payout will become part of your estate. Depending on the value of your estate, inheritance tax may have to be paid before your dependants receive the money.

If you write your policy in trust, the payout escapes any inheritance tax and goes directly to your trustees without being held up by probate. This means that the payout cannot be used to clear any debt.

It is relatively easy to do as most insurance policies include the option (and papers) for writing in trust directly at no extra charge. Note that there are different types of trusts and they can be difficult to change or cancel, even if all your beneficiaries agree, so think carefully about who a payout would be going to.

If you know what you're doing, you can write the policy in trust yourself. If not, seek advice from a top advisory broker or a solicitor.

Frequently asked questions