One of the biggest mistakes that many new homeowners make is taking a mortgage life insurance policy. It’s not that it’s a bad idea in theory, it’s just that there are better ways to provide insurance for your family, including an allowance for paying off your mortgage. In most cases, this can be better accomplished with a simple term life insurance policy.
What Is Mortgage Life Insurance
A mortgage life insurance policy is exactly what the name implies. It’s a life insurance policy that is specifically tied to payoff of your mortgage. You can think of it as the biggest example of credit life insurance.
As an example, let’s say that you take a $200,000 mortgage on your house. In order to make sure that your family will be able to live in the home free and clear upon your death, you also take a mortgage life insurance policy for $200,000 – the exact amount of the mortgage balance owed. Upon your death, the mortgage on the house will automatically be paid off.
A mortgage life insurance policy is not only tied to your mortgage, but it is also designed to match it almost precisely. These policies are also known as decreasing term policies, because the amount of the death benefit decreases with the mortgage.
As well, the term of the policy also matches your mortgage. If you have a 30 year mortgage, your mortgage life insurance policy will be a 30 year decreasing term policy.
Mortgage life insurance should not be confused with private mortgage insurance, or PMI. PMI is insurance that is required by lenders to reduce the amount of exposure that they have in the event that you default on your mortgage. Mortgage life insurance the other hand is designed to pay off your loan completely in the event of your death.
But there are several reasons why you’d be better served with a simple term life insurance policy, rather than a mortgage life insurance policy.
A Term Life Insurance Policy Can Do the Same Thing as Mortgage Life Insurance
The appeal of mortgage life insurance is that it is a policy that’s tied to a very specific liability – one that people worry about in regard to their deaths. Who wouldn’t want to know that, come what may, their mortgage will be paid off? It’s one of the best ways to provide for your loved ones after your death.
But straight term life insurance can do the very same thing. You can take a term policy in an amount that matches your mortgage amount, and generally do so with more benefits to you and your loved ones than a mortgage life insurance policy will.
Here’s why…
Term Life Insurance Costs Less than Mortgage Life Insurance
One of the biggest reasons is cost. As a rule, mortgage life insurance costs more than straight term. This is partially because of the higher administrative costs of managing the decreasing term nature of the policy, and also because it serves a very specific purpose.
The biggest single factor however is that mortgage life insurance policies typically carry fixed premium rates, even though the amount of coverage declines with the amortization of the underlying mortgage. You will pay the same premium 20 years into a 30 year mortgage, when the balance is just $100,000, as you did when the loan was at it’s original high balance of $200,000.
A term life insurance policy will also have a fixed annual premium, but the death benefit will never go down. Your premium will always buy you the original death benefit.
Term Life Pays Your Beneficiaries – Mortgage Life Pays the Lender
This is a provision of mortgage life insurance policies that a lot of people aren’t aware of. But since it is an insurance product designed specifically to pay off your mortgage, the proceeds will go directly to your lender upon your death, and not your beneficiaries.
On one hand, this can be a positive outcome – it virtually guarantees that the policy will function as intended upon your death, with no possibility for human error.
But what happens if your family has a greater need than paying off the mortgage? The option to use those funds for that purpose will not exist, because the destination of the death benefit is locked with a mortgage life insurance policy.
Level Term VS. Decreasing Term
A straight term life insurance policy has a fixed benefit level, and as discussed, mortgage life insurance is decreasing term. Once again, the advantage here goes to the straight term life insurance policy.
If you take a mortgage life insurance policy to payoff your mortgage, the policy will do that – but nothing more. It is a single use policy. But if you take a term life insurance policy, loosely earmarked to payoff your mortgage, 20 years into the loan, when the mortgage is paid down by about half, the balance of the death benefit will be available for your loved ones for what ever purposes they may need it for.
It’s simply a better option to have.
Skip the Mortgage Life Policy and Go With a Term Life Insurance Policy Instead
Considering all of the factors above, straight term life insurance simply offers more options to your loved ones, and at a lower price. So if you’d like to have your mortgage paid off upon your death, keep it simple, and go with a regular term life insurance policy. You don’t need anything more specific than that, and you certainly don’t want to pay extra for it.
