Is Mortgage Life Insurance a Smart Move?
The sales pitch for mortgage life insurance can be pretty convincing: This insurance will pay off the rest of your mortgage loan should you suddenly die.
The banks and lenders that offer mortgage life insurance say that it can provide extra financial protection for your loved ones, freeing them from the burden of having to make monthly mortgage payments that they might not be able to afford.
But is mortgage life insurance really a smart investment? Insurance and financial experts argue that it usually isn't, unless it's the only type of life insurance for which you can qualify.
A limited benefit
The reason? It's too limited in its scope. And unlike traditional term life insurance, the beneficiary of a mortgage life insurance isn't your spouse or children. It's your lender.
Mortgage life insurance is an example of what is known as creditor insurance: This type of insurance pays off an outstanding balance -- a consumer's mortgage in this case -- when a policyholder dies. Tammy Johnston, president and chief executive officer of The Financial Guides in Calgary, says that creditor insurance never offers the same level of protection as does traditional life insurance.
"I teach a personal finance course, and one of the subjects covered is the difference between having real insurance and creditor insurance," said Johnston. "You are just paying a ton of money with creditor insurance to gamble with your financial future should anything go wrong, and I have seen a lot of different things go wrong for people during my 23-plus-year career."
Other costs still remain
The biggest negative of mortgage life insurance is that it only does one thing: When you die, your survivors can only use that money to pay off your mortgage. If they instead need the funds to cover other expenses -- such as a child's college education -- the policy will provide them with little help.
Financial pros recommend that consumers invest instead in a traditional term or permanent life insurance policy. That way, when policyholders die, their named beneficiaries can use the death benefit payout to cover whatever expenses they face. They could use the money to pay off an existing mortgage. Or they could use it to cover daily living expenses or to eliminate credit-card debt.
"Mortgage insurance may not be the best choice for everyone," said Levar Haffoney, wealth manager with Fayohne Advisors in New York City. "Although the mortgage would be paid off, there are other costs associated with the house that would still have to be paid."
Consider regular life insurance
The better option, Haffoney says, is a more traditional life insurance policy, which survivors can use to pay for home repairs, say, if they need to suddenly replace a leaky roof or sagging foundation.
When choosing life insurance, homeowners generally have two choices: a term life or permanent life policy. A term life insurance policy is cheaper. It provides financial protection for a set number of years, say 20. If you die during the term, the policy will pay out the death benefit that you set when you created it. If the policy reaches the end of its term without your death, you can either renew the policy or let it expire if you no longer need life insurance.
A permanent life insurance policy never expires as long as you keep making your payments. They also usually contain what is known as a “cash value” component. Part of your payments fund your life insurance protection. Another part is invested in a savings vehicle that generates interest. If you die, your beneficiaries receive both the death benefit and the accumulated cash value.
You can also invest in what is known as decreasing term life insurance. In this type of policy, your death benefit gradually decreases over time. This kind of insurance is less expensive than either permanent or standard term life.
How mortgage life insurance works
When you take out a mortgage life insurance policy, you pay a regular fee -- whether monthly or annually -- to a bank, mortgage lender or insurance company. When you die, the financial institution behind your policy will pay off the remainder of your mortgage.
That sounds like a smart solution. But financial pros say that mortgage life insurance actually decreases in value the longer you have it. That's because you'll be paying down your mortgage over time. Say you take out your mortgage life insurance policy when you owe $200,000 on your mortgage. If you die the next day, your policy will provide about $200,000 to pay off the remainder of your mortgage.
But what if you die years later when you owe just $120,000 on your loan? Now your mortgage life insurance policy only pays out $120,000, $80,000 less than when you originally signed up for it.
This is another reason why financial experts recommend a term life or permanent life insurance policy as a replacement for mortgage life insurance. In both policies, your death benefit will remain constant unless you change your coverage intentionally.
"I absolutely think that people should buy their own individual term life insurance product to protect the mortgage," said Saul Simon, certified financial planner with Edison, New Jersey-based Simon Financial Group. "You get to determine if you want to lower the face value."
Does mortgage life insurance ever make sense? Maybe in one situation. Financial pros say that if, for whatever reason, you can’t qualify for traditional life insurance, a mortgage life insurance policy is better than having no protection at all. Mortgage life insurance policies don’t require medical exams, so you’ll be able to qualify for one even if a medical condition makes it a challenge to find an affordable traditional life insurance policy.
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