Before looking at various terms, insurance plans, and the purposes, advantages and drawbacks of these products, when thinking about mortgage life insurance the buyer should ask the question, ‘why am I buying this type of policy?’ Assuming the mortgage is on the buyer’s principal residence (their home), the obvious answer might seem to be, ‘because I want to pay off the mortgage on my home.’ And this answer is accurate for most people. However, it raises the more specific question, ‘what is the best insurance plan to pay off the mortgage on my home?’ Yet, that is not the end of the questions for some buyers. Other questions may be important, such as: ‘What are the tax consequences of paying off my home versus paying the proceeds directing to my beneficiaries? And, ‘Does my spouse, children, or beneficiary want to live in the home, or would they prefer or be better suited selling the home and using the proceeds to buy another?’
- Mortgage Credit Life Insurance (occasionally called Loan Cancellation Life Insurance): This is a term life insurance contract that is taken out by the borrower and issued by the bank or mortgage lender to cover the balance of the mortgage. Mortgage lenders will typically offer this policy at the loan closing. The premiums are tied to the mortgage payments with interest. The policy is normally designed to protect the lender more than the buyer’s beneficiaries.
- Mortgage Life Insurance: This is a life insurance policy that is designed to repay the balance owed to a bank or mortgage company upon the policy owner’s death. The beneficiary is normally the bank or mortgage lender. It is sometimes called ‘private’ mortgage life insurance when it is not purchased through the lender, or a third party insurer associated with the bank or lender. There are two basic types of mortgage life insurance: Decreasing Term Insurance, where the death benefit decreases as the mortgage balance decreases; and Level Term Insurance, where the death benefit does not decrease.
- Life Insurance for Mortgage/Rent/New Home purposes: One option which often provides more flexibility and benefits is for the buyer to purchase one of the traditional level Renewable Term Life Insurance Plans or a long-term Whole Life Insurance or Universal Life Insurance plan. In this situation the owner retains all control over the policy, and the beneficiary or beneficiaries typically receive the death benefit tax-free, and have more flexibility in their choices of how to use the proceeds.
- Private Mortgage Insurance (PMI): PMI, or Lenders mortgage insurance, is not life insurance. It is insurance that protects the lender instead of the borrower, in the event that the borrower defaults on their mortgage loan. PMI is required in certain jurisdictions for mortgages with a down payment that is less than 20% of the loan. (The Homeowners Protection Act of 1998 addresses canceling PMI premium payments).
• ADVANTAGES OF MORTGAGE CREDIT LIFE INSURANCE:
- Credit life insurance in general is listed by financial planners as one the worst types of insurance to buy; however, if the buyer has medical conditions which make them highly rated or uninsurable, then it could make sense to purchase a guaranteed issue mortgage credit life policy, or a No-Exam Life Insurance plan.
• DISADVANTAGES OF MORTGAGE CREDIT LIFE INSURANCE:
- A Reader’s Digest article in their ‘Money Digest’ section stated ‘mortgage life insurance’ that ‘typically goes directly to a mortgage lender, not to your family’ and that is ‘typically 200 to 300 percent more expensive than term life insurance …aren’t worth the money …(except) for people who have a medical history that makes term life insurance prohibitively expensive.’ They are on average 2 to 3 times the cost of other term plans.
- Another disadvantage is if the insurance premiums are rolled into the loan amount, the borrower is paying interest on the premiums.
- Another significant drawback is that because the life insurance proceeds go directly to the lender and not the beneficiary; the spouse, children, or other beneficiary lose both the option of using the proceeds to put towards another home choice, and receiving the proceeds tax-free. Whereas, if the home is paid off, it could result in higher state and or federal estate taxes (2013 ‘exemption’ is currently $ 1 million) and probate fees.
Note: Mortgage credit life insurance is often pushed by lenders; however, by law it is not mandatory, and must be entered into willingly by the buyer.
• ADVANTAGES OF PRIVATE MORTGAGE LIFE INSURANCE:
- Individuals close to or better than an average or ‘standard’ life insurance rating (see The Underwriting Process or What is my Health Class or Rating?) are likely able to buy mortgage life insurance cheaper through a life insurance company on their own, and not through the lender.
- Buyers who purchase mortgage life insurance through an insurer not affiliated with the lender will typically exercise more control over their owner rights and benefits.
• DISADVANTAGES OF MORTGAGE LIFE INSURANCE:
- Often level term plans can be purchased for about the same price as a decreasing term mortgage life insurance product, and thus the level term product could net additional proceeds.
- If the private mortgage life insurance policyowner makes or assigns the lender as the beneficiary, then the home or mortgage property will automatically be paid off regardless of the desires of the spouse/children/ or other beneficiary.
- In a decreasing term mortgage life insurance plan tied to the mortgage, since amortization is reducing the mortgage balance with each monthly payment (especially if extra payments are being made), then this type of life insurance coverage is also decreasing while the premiums are not.
• ADVANTAGES OF A TRADITIONAL LIFE INSURANCE PRODUCT:
- When a traditional level term product is used for a mortgage fund, it affords more flexibility, and is often less expensive.
- When the policyowner makes their loved ones the beneficiaries instead of a financial institution, then the owner is allowing them the flexibility often needed to make the hard transitions during their time of loss.
- When traditional life insurance is used (term, whole life, or universal life, or a combination thereof), the buyer can use it or a portion of it as a mortgage fund, or rent fund. And if the insured buyer sells their home and buys another, or if they are renting and want to insure than a fund will be available in the event of their death for their loved one(s) to continue renting for a certain period, or in order to buy a home, then purchasing life insurance in this manner gives them that control, flexibility, and benefit.
- Occasionally homeowners will buy a Whole Life Insurance or Universal Life Insurance product which will give them the coverage desired, and later use its cash value to pay off a portion or all of the mortgage balance.
• DISADVANTAGES OF TRADITIONAL LIFE INSURANCE:
- If the borrower of a mortgage would be highly rated or uninsurable, than a guaranteed credit or mortgage life insurance product would likely be more affordable.
Before buying a life insurance policy for a mortgage, loan, or any other reason, the buyer should compare the various types of life insurance plans that are designed to meet their desired goals.
• FOR MORE INFORMATION (see the following articles):
How much coverage do I need? – This link may help you determine the amount of life insurance protection or coverage you require.
What policy should I buy? – This link may help you decide which life insurance product is the best for you.
What term period should I select? – This link addresses the various level term periods available, some purposes for their design, and looks at questions you could ask to help determine your choices.
Advantages & Disadvantages of Term Life Insurance – This link addresses the most important advantages and disadvantages to term life insurance plans.