Life insurance for mortgages: Things to know before buying

How mortgage life insurance works...

Purchasing a home is an exciting time in a person's life. However, once you buy your home, you may start to receive adverts prompting you to insure your mortgage. 

Before you opt into any kind of Life insurance policy, there are some things worth considering... Let’s take a look!

In this Article:

• What is a mortgage life insurance policy?
   

• How does mortgage life insurance work?
   

• Why buy mortgage life insurance?
   

• How much is mortgage life insurance?
   

• Alternatives to mortgage protection insurance 

How it works

Mortgage life insurance is available in 2 types of term life cover:

Decreasing term

With this type of life insurance, as you pay off your mortgage, the eventual pay-out decreases over time. Note that the sum assured on a decreasing term policy is not usually directly aligned to the outstanding mortgage balance it is covering.

Instead, the sum assured will reduce at a certain interest rate every year (usually between 6% and 8%) meaning that if your mortgage has an interest rate higher than this, then the policy may not clear your total debt.

This type of cover mainly applies if you have a repayment mortgage.

Level term

Conversely, you could choose level term life insurance. The great thing about this policy is that whether you die in the first or last year of your policy term, your family will receive the full sum assured as the cover amount remains the same throughout coverage, your family still receives the maximum pay-out.

Typically, the length of your policy can be calculated by how long you expect it to take for you to pay off your home's mortgage.

Check out - ‘When is the right time to buy life insurance?’ for more information.

Level term cover may be more suitable if you have an interest-only mortgage. This is where your monthly payments are used to cover the interest on your loan and not the amount borrowed. You'll still owe the original amount you borrowed at the end of the term.

There is an alternative type of insurance for a mortgage called mortgage payment protection insurance (MPPI).

Unlike mortgage life insurance, this policy covers your monthly mortgage payments if you lose your job or become ill, lasting between 1 or 2 years. Unfortunately, this type of policy is not available through Cavendish Online.

Why buy mortgage life insurance?

Buying a house isn’t just about having your own place to live, it’s also an investment that requires protection.

Though it’s not legally mandatory, it is recommended that you opt to purchase life insurance for your mortgage. Many mortgage lenders encourage taking out a policy alongside. Some lenders may offer a policy - however, it may not be the best option financially, so it’s better to shop around.

Nobody wants to leave their family to pay an outstanding mortgage balance. Instead, what they really need is peace of mind for the future ahead.

Whether you choose to buy mortgage protection insurance or not can depend on if you have others to provide for. If you’re a single homeowner, you may be less likely to need to take out a mortgage life insurance policy.

Other insurance options could be beneficial, like mortgage payment protection insurance, as these pay towards your mortgage should you lose your job or become too ill to physically work.

If you want a solution for coverage of more than just your mortgage, you may also consider purchasing level term life insurance. This can help towards:

• Living costs – to help your family cope financially

• Childcare and education costs

• Outstanding payments you may have - such as loans or credit card debt

• Education costs (such as university or school fees)

• Funeral costs

• Income replacement

Obviously, if you don’t own or rent a property, you might not need a mortgage policy - but it’s still worth considering taking out some form of life insurance to protect your loved ones.

How much to consider when buying mortgage life insurance for cover?

When applying for mortgage life insurance, certain factors can affect the cost of your policy, like:

The main thing to take from this is: the younger and healthier you are, the less you are likely to pay towards your monthly premiums.

You can also ensure that the payout is financially protected by putting your policy into trust. By doing this, you protect the value of the payout from being hit by inheritance tax, as the payout won't fall into your estate so isn't taxed when your family inherits it. For more information, you can visit our article about writing your policy in Trust.

Single or joint mortgage life insurance?

In some cases, a joint life insurance policy can work out cheaper. If you and your partner both contribute towards a mortgage, then it might be worth taking out a joint policy to protect you both if the other dies. This can be offered by some insurance providers and can work out easier to manage and cheaper than taking out separate policies.

This type of policy comes in two forms - first death & second death. With joint life first death, the policy pays out when the first person dies. Once this happens the policy ends, so the second person may still want cover. With joint life second-death, the policy pays out after both policyholders have died.

It's also worth checking with your employer if they offer a death in service benefit. It can give your loved ones financial support if you were to die whilst employed by the same business. It's possible to have multiple life insurance policies, though it obviously comes at an extra cost.

Pros and cons of mortgage life insurance

Like most things, there are always pros & cons to consider. With mortgage life insurance, you need to take your circumstances into account to find the best policy for you and your loved ones. Before you do this though, you should be aware of the benefits & negatives of this type of policy:

• Pro: The monthly premiums for decreasing term life insurance are usually cheaper when compared to the other policy types.
   

• Con: Though the premiums are typically cheaper for decreasing cover, the pay-out decreases as you pay off your mortgage. So, your loved ones could end up with a lot less than hoped for to help with costs besides the mortgage.
   

• Pro: Your policy can be put into trust, preventing the payout to your family from being hit with inheritance tax.
   

• Con: If you choose a decreasing term policy, it may not be suitable if you have an interest-only mortgage. Level term works well if you have an interest-only mortgage. but is also more costly than decreasing term.

Alternatives to mortgage protection insurance

In some cases, mortgage protection insurance may not be the best approach. Perhaps you require longer-term protection or cover for health issues?

Fortunately, alternative solutions are available:

Life insurance

• Life insurance, similar to term life insurance, allows your family to spend the money where they see fit. Though, unlike the latter, there is no fixed limit. You also have the option to specify how the money is spent, for instance, on mortgage payments.

• Whole life insurance is typically the most expensive form of cover. Whole life policies cover you for the remainder of your life. Unlike term life cover, your family is guaranteed a pay-out no matter when you die (as long as you keep up with your premium payments).

Critical illness cover

• With this type of insurance, you’ll receive a tax-free lump sum, if you become seriously ill or disabled. The payment is to help with living costs including your mortgage loan. Your provider will state what illnesses or disabilities you’re covered from.

Income protection insurance

• Another option is income protection insurance. This usually gives you around half or two-thirds of your usual salary if an accident or illness prevents you from working. It can provide you with a salary until you’re able to return to work, retire or if the policy ends.

Family income benefit

• When you die, your family receives monthly tax-free payments to make up for the loss of income. When applying, you decide your level of cover - the higher the amount, the greater your premiums. A family income benefit generally lasts until a specified date (the end of the policy term).

Help from the Government

• If you run out of options, the Government may support you in paying your mortgage. You can seek Jobseeker’s Allowance and Employment and Support Allowance if you’ve been made redundant or cannot work.

• There is also the Mortgage Interest Scheme (SMI) – The Government will pay some or all of the interest on the first £200,000 of the mortgage[1]. Sadly, with these schemes, there isn't always a guarantee that you will be eligible to apply.