One of the most unique types of life insurance is mortgage life insurance. Many banks require mortgage applicants to underwrite this type of insurance. Its purpose is to cover the bank in case of the death of the client who took out the mortgage. If the client dies, the insurance makes a payout to the bank which then serves to cover the remaining mortgage amount.
In this article, we will explain how life insurance that is linked to a mortgage works. If you are looking for funds to buy real estate property, it is important that you consider all of this information.
About Mortgage Insurance: Table of Contents
Mortgage Life Insurance: What is It?
Mortgage life insurance is a special type of life insurance. In contrast to other products from insurers, it was not created to provide peace of mind or secure the future of the insured, but rather to satisfy the demands of the banks that grant mortgages.
A mortgage on real estate property is one of the most uncertain products that banks offer on the market. They tend to come with very high prices and have very lengthy payback periods that can stretch over decades, so there is a real risk that the mortgage holder may die before paying all of the money back to the bank. In order to guarantee that the mortgage will be paid back in full, many banks require their customers to underwrite life insurance, the beneficiary of which is the bank itself: if the client dies before having paid the mortgage, the bank will cover what is left by enforcing the policy.
In case of borrowers with a serious incurable illness and a life expectancy estimated at less than a year, there are insurance policies that will make the payout during the lifetime of the insured so that he or she can pay off the mortgage before dying.
In addition, some of these policies make payouts in the case of a permanent disability that prevents the mortgage holder from generating income.
In these circumstances, the policy will also be responsible for the part of the mortgage loan that must still be repaid to the bank.
In other words, mortgage life insurance, or life insurance linked to a mortgage, has one single mission: return the mortgage money to the bank in the event that the mortgage holder cannot do so due to death or physical impairment.
Therefore, if you are thinking of taking out a mortgage to buy a home, a business locale, or other type of real estate property, it is very likely that your bank will require you to purchase one of these policies. Remember that you can refuse to do so, but this may complicate the loan approval process, and it is very likely that the bank will require you to sign documents where you expressly waive the coverage.
If you agree to purchase a mortgage with life insurance, you should know what the main elements of this coverage are and how they are different from the components of a conventional life insurance policy.
- Premiums. The monthly premiums of mortgage life insurance are calculated relative to the mortgage to be repaid. The bigger the loan, the greater the risk, and therefore, the larger the premiums. However, as these policies are acquired for a set time that is equivalent to the duration of the mortgage, premiums are generally not too expensive. Generally, premiums are added to the monthly mortgage fees.
- Beneficiary. For mortgage life insurance, the beneficiary is always the bank (or banks, in the case of joint loans).
- Payout. The payout, or death benefit, is the amount of money that the beneficiary–that is, the bank–will receive in the event that the mortgage holder dies. At any given time, the payout will be equivalent to the unpaid mortgage amount. So in contrast to other types of insurance, the benefit decreases with time, as the loan installments are paid.
- Term length. The term length of this type of policy must be equal to the duration of the mortgage. This means that when you pay the last installment of your loan, the life insurance expires and is no longer valid. In this sense, mortgage life insurance is a special type of term life insurance, in that it also covers a determined period.
- Customization. Although mortgage life insurance was created to cover the risk of banks, some insurance companies offer customized policies at a slightly higher cost that provide additional benefits. Aside from complying with the bank’s requirements, these policies offer the insured extra advantages such as coverage for children if their parents die, payouts for beneficiaries designated by the insured, payouts in case of traffic accidents, and more. If you are going to purchase mortgage life insurance, talk to your insurance company about what "extras" may be available to improve your base policy.
How Mortgage Life Insurance Works
As you have seen, mortgage life insurance is quite different from conventional life insurance. Mortgage life insurance is similar to term or temporary life insurance to a certain extent, but there are important fundamental distinctions, and above all, it is noticeably different from permanent life insurance.
The most significant distinguishing factor of mortgage life insurance is that the death benefit decreases as you pay off the loan. This means that the payout total adjusts to what is left to pay on the mortgage. However, the premiums stay the same.
Additionally, the process to qualify for mortgage life insurance also differs significantly from that of conventional insurance. Since the bank is the one requiring the coverage, the are practically no restrictions on the insurance application. In this aspect, mortgage life insurance is similar to term insurance, which also has fewer requirements for qualifying.
With this type of life insurance, it is enough to fall within a certain and rather wide age range in order to qualify and receive the policy. This means acquiring significant coverage without having to suffer through the underwriting process.
After underwriting the insurance, it becomes part of your mortgage. As such, you will pay the premiums as you pay off the loan, generally as one single payment. This means that the price of your insurance is added to the mortgage, making it more expensive.
However, you are not legally obligated to underwrite mortgage life insurance. It is a bank requirement that you have the right to refuse, although if you deny it, it may be harder to obtain a mortgage and your banking entity will require you to sign documentation that proves you have waived the insurance.
Advantages and Disadvantages of Mortgage Life Insurance
Given that mortgage life insurance is not mandatory, you must carefully evaluate whether you want to purchase it along with your mortgage. If this is the case, you should carefully consider the advantages and disadvantages that these products offer. Among the advantages, we should emphasize:
- Ease of qualification. They will not ask for medical exams nor ask you any questions other than your age. This is a great advantage when acquiring life insurance, because the qualification process is practically nonexistent. If you have not been able to qualify for term insurance, for instance, you can turn to mortgage life insurance to protect your properties and guarantee that your family will still be able to count on your mortgaged home after you die.
- Security for your spouse. Very often, the mortgage is in the name of both spouses. If one of the two dies, the other must pay off the entire loan, which may be very difficult. With mortgage life insurance, the part of the mortgage corresponding to late spouse is covered by the policy, and the surviving spouse continues to pay only the part corresponding to them.
- Coverage in case of disability or terminal illness. Many mortgage life insurance policies offer payouts in the event that the insured person has a health problem that leaves them handicapped or if he or she has a terminal illness with a very short life expectancy. This allows for a payout of the benefit even if the insured has not died.
On the side of disadvantages, there are several considerations that make this insurance option problematic and less attractive:
- Decreasing benefit. Perhaps the biggest disadvantages of this insurance is that the payout decreases with time as the mortgage loan is paid off, until it reaches zero. This means that the benefit decreases despite the fact that the insured has paid the premiums.
- The beneficiary is the bank. Generally, this type of insurance does not benefit the successors of the late insurance holder, but the bank. In exchange, the successors—generally the family—have a real estate property that is fully paid and mortgage-free.
- Higher price. Since the premiums are fixed but the benefit decreases, the cost of mortgage life insurance is actually much higher than that of other types of life insurances.
As you can see, the disadvantages are significant. So if you a required to purchase mortgage life insurance, your best option is to get coverage by purchasing an additional life insurance policy, whether temporary or permanent, that will provide your family and loved ones with a benefit that can also be used for other expenses, not just the mortgage.