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Should I Get Mortgage Life Insurance?

When you are approved for a mortgage and are filling out the paperwork, it can be easy to overlook exactly what you’re signing. There are a lot of places to sign or initial, and you may just want to get it over with as quickly as possible.

But if you don’t pay careful attention, you can end up spending hundreds or even thousands of dollars more than you need to because of something called mortgage life insurance.

On the surface, mortgage life insurance seems like a good deal. But is it really? Let’s take a look at what mortgage life insurance is, and if there are better alternatives.

 

What Is Mortgage Life Insurance?

Mortgage life insurance is a type of insurance offered by your mortgage lender when you take out a mortgage. It covers the remaining balance of your mortgage in case you become disabled or die before the mortgage is paid off. Mortgage life insurance is also different from mortgage default insurance.

This can offer peace of mind to homeowners as you wouldn’t have to worry about how your family would afford the house with you around, but it isn’t all it’s cracked up to be.

Benefits of Mortgage Life Insurance

-        Covers the cost of your mortgage

-        Does not require medical examination

-        Rolled into your mortgage payment so it’s just one monthly bill

But there are several important distinctions that make mortgage life insurance not quite as desirable as it sounds.

The first major problem with mortgage life insurance is that it only pays off the remaining amount of your mortgage, rather than a set amount. While that ensures you’re always fully covered, it also means you’re paying the same premium every month for a decreasing amount of coverage. That’s right – your premium won’t decrease during your term, despite paying off a portion of your mortgage.

The second problem is that the beneficiary is your bank, not your family. That allows your family to live mortgage-free in the house, but they might have other more pressing financial needs such as funeral expenses or high-interest debt. They don’t get the choice on how to spend the money.

Let’s not forget that renewing your mortgage life insurance policy may in fact be more expensive, rather than less, when you renew your mortgage. You might think that, since you need to cover less money on renewal, you would have to pay less in premiums. But you might end up paying more since you’re older – and therefore more likely to experience an injury or death. That results in higher premiums.

But possibly the largest problem is that mortgage life insurance policies aren’t underwritten until after the policyholder is injured or dies. This lets you sign up in a few seconds when you’re signing your paperwork, but it also means you could be denied coverage when your family actually tries to collect. You get the premiums you paid back (without interest), but that isn’t the point. After the fact, it’s too late to get a life insurance policy.

You might have chosen mortgage life insurance instead of regular life insurance because of the cost and convenience, but if it ends up not being what your family needs – or if you’re denied altogether – that money and time is wasted.

That is money you could have put towards a life insurance policy that had a stable payout and was already underwritten so you can’t be denied coverage when you need it most.

It’s nearly always better to get a term life insurance policy for the mortgage amount.

 

Term Life Insurance

Term life insurance is usually purchased when you have a large financial obligation that would be hard for your family to afford without your income. The idea is that you have coverage for when you need it, but after the term ends that financial obligation is lessened or gone entirely. For example, you might purchase a 20-year term life insurance policy after buying a home. You’ll be covered for the first 20 years of a typical 25-year mortgage, and the least 5 years won’t need coverage because you’ll only owe a fraction of what you did when you took out the policy.

What makes term life insurance policies so good is that they’re relatively cheap for young people, even when taking out coverage for a large amount.

A 33-year old male non-smoker can get a 20-year term life insurance policy for $500,000 at just $26.73 per month. That works out to just $6,415.20 over the whole 20 years of the policy! Let’s compare what would happen if that 33-year old purchased the same $500,000 home and had to choose between mortgage life and term life insurance.

 

Case Study

For this case study, here are the numbers used.

Home Purchase Price

$500,000

Interest Rate

3.45%

Down Payment

5%

Mortgage Required

$494,000

Amortization

25 years

Mortgage Life Insurance Premium

$20/month for the first 5 years, +$5/month every 5 years

Term Life Insurance Premium

$26.73/month

 

It’s impossible to predict what interest rates will be for the whole life of a mortgage. Interest rates fluctuate over time, and there’s no pattern to their ups and downs. For this example, I’ll assume a fixed interest rate of 3.45% over 20 years, which is higher than the current best 5-year mortgage rate of 2.89%. I did this to account for possible future increases.

With these numbers, the total mortgage remaining after 20 years would be $135,385. If he took out a mortgage life insurance policy, his payout amount would be the same – $135,385. The total cost of premiums over those 20 years would be $6,600: remember, premiums go up with every renewal. Subtracting the premiums paid from the payout shows that the actual benefit earned would be $128,785.

If had had instead opted for a term life insurance policy, the payout would be the same as when he took it out - $500,000. The premiums would total $6,415 for a benefit of $493,585. That leaves $364,800 left over after paying off the mortgage, which can be used however the family wants.

But what if the policy had to be used earlier, like after 5 years? In that case, the premiums paid for mortgage life insurance would total just $1,200, compared to the $1,604 for term life insurance. However, the payout for mortgage life would cover $426,027 compared to the $500,000 from the term policy. For $400 in more premiums, you could get $73, 569 more in coverage!

 

Pay Attention While Getting Your Mortgage

Mortgage life insurance is pushed by mortgage specialists and brokers who get a commission off selling it to you. In nearly every case it makes more sense to just get a life insurance policy. However, a mortgage life policy is better than no insurance at all.

Before you agree to pay for mortgage life insurance, compare life insurance quotes online to see if you can save yourself some money and better protect your family.


Chris Chris 04/08/2019
Canadian personal finance buff and all-around writing enthusiast, Chris loves breaking down complicated money ideas to show that they're really not so complex. 
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