Mortgage life insurance: What it is — and isn’t
Richard J. Koreto
For some people, mortgage life insurance — which pays off the remainder of your mortgage in the event of your death — provides peace of mind. However, there are drawbacks to mortgage life insurance that consumers need to know.
A mortgage life insurance policy sounds straightforward, but many people get confused about the details, says Raquel Murphy, a life, disability and long-term care insurance specialist at HUB International Northeast.
“When someone comes to me asking about mortgage life insurance, nine out of 10 times they are confusing it with mortgage insurance, which is completely unrelated to mortgage life insurance,” she says.
Mortgage insurance — called private mortgage insurance (PMI) — protects your lender in case you default on your loan. It doesn’t pay anything to your family if you die.
Mortgage life insurance, however, is a life insurance policy tied to what you owe on your mortgage. If you buy a $250,000 house with 10 percent down, you’d want a $225,000 policy. Of course, every month you owe a little less on your principal, and your life insurance payout changes to reflect this. Years from now, when you owe only $100,000 on your mortgage, for example, that’s all your policy will pay.
You’d think that as your life insurance proceeds decrease, your premiums would go down correspondingly, but this isn’t the case. In fact, they won’t go down at all, according to Frank Donnelly, president of the Mortgage Bankers Association of Metropolitan Washington.
What are the advantages, then, to buying a mortgage life insurance policy over a regular term life insurance policy? Actually, there aren’t many. Donnelly recommends getting a 30-year term policy, which offers fixed proceeds.
Paying off the mortgage isn’t always the priority
New homeowners may feel comforted knowing their mortgages will be taken care of no matter the circumstances, but fixed-term policies of 20 or 30 years usually are a better option because your needs are likely to change over time. That is, today your house might be your biggest concern, but Murphy notes that later on you’ll want money for other things, such as college tuition for your children.
A typical term life insurance policy will do that for you. A mortgage life insurance policy won’t, as its proceeds can be used only for the mortgage. Moreover, if you’re buying a policy specifically for mortgage protection, you can time the term to end when your mortgage should be mostly or entirely paid off. At that point, you can collect your money.
An additional consideration: Sometimes there are good financial reasons to not pay off a mortgage all at once. For example, if a couple buys a house at a low rate and one of them dies, the insurance proceeds probably will do more good invested in the stock market or an interest-bearing account than they would paying off the mortgage — provided that the surviving spouse can continue to make the monthly mortgage payments.
Nevertheless, there are a few benefits to mortgage life insurance, financial adviser Vincent Barbera says. Although Barbera prefers the flexibility of term policies for his clients, he sees a couple of reasons to consider mortgage life insurance:
• It can be easier to obtain. “There is usually no medical examination necessary,” Barbera says. “So if a homeowner had some pre-existing conditions that would preclude them from qualifying for a term policy, then it can make some sense.”
• Some people actually like that there’s no choice in how the payout is spent. The mortgage insurance policy pays off the mortgage — end of story. “They have peace of mind knowing that their mortgage is taken care of,” Barbera says.