What is Mortgage Life Insurance and How Does it Work?
Mortgage life insurance is, at its core, life insurance that pays off your mortgage if you die. The sales pitch is pretty simple:
You wouldn’t want to burden your spouse with having to deal with mortgage payments after you die or become terminally ill, so buy some piece of mind with mortgage life insurance. If you DO die, your mortgage debt will be cleared and your spouse will own their home outright.
Sound like a smart thing to do, right?
If you have life insurance, you should already be questioning the value of mortgage life insurance. In both cases, you die, and someone gets a payment based on the policy. But there are many differences that are important to understand. Let’s take a look.
Who Gets The Money?
With life insurance, it’s easy – you decide who the beneficiary is and they get the money. If you choose your spouse, they’ll simply file the claim when you die, and the insurance company will pay out the policy amount.
With mortgage life insurance the beneficiary is actually the institution who owns your mortgage. If you have your mortgage through your bank, then THEY, not your spouse, collect the money and then clear the debt you owe on your mortgage.
What Can The Money Be Used For?
With regular life insurance, the beneficiary is free to spend the money however they want. They can pay off debts, pay off the mortgage, pay for tuition for the kids, invest it, or donate some to a charity.
There are no limitations on what the money can be used for.
With mortgage life insurance the money can only be used for one thing: paying off your mortgage. Some banks also include other debt payments. For example, TD Bank will also pay off up to five years’ worth of accrued interest as well as any money owed in your tax account.
Is Mortgage Insurance Worth It?
Hopefully by now an alarm is flashing somewhere in your head. With a standard life insurance policy, you choose a coverage amount (let’s say $500,000), and pay a monthly premium based on your age and other factors. In 10 years, your policy amount is still $500,000, and you’re still paying the same premium (assuming a 10-year term).
With mortgage life insurance, let’s say you take out a policy on your $500,000 mortgage. On day 1, things are pretty much the same. If you die the day after you buy your house, the bank will get the $500,000 and clear the debt.
But what if you’ve lived in your home for 10 years and only owe $250,000? All of a sudden the payout for the mortgage life insurance policy is only $250,000, and you’ve been paying the same premium the entire time.
Over the life of your mortgage, you’ll constantly be paying a relatively higher premium for a smaller policy.
Running The Numbers
Everyone’s situation is different, but it’s important to run the numbers on your exact situation.
Most banks charge lower rates the younger you are, and the rate is sometimes based on how much you owe on your mortgage. So as you owe less on your home, the rate goes down, but you’re also getting older, which increases the rate. (note: every policy is different – make sure you understand how each one works when making your comparisons).
Start with your own bank and calculate the cost of mortgage life insurance over the life of your mortgage.
Compare that to a similar value of term life insurance. Remember that term insurance will get cheaper as the policy amount will go down as time goes on (for a comparison to the mortgage insurance – in reality you’d probably keep it the same).
Insurance is one of the foundations of a solid financial plan for your family and should never be overlooked. It’s always important to weigh your options and factor in costs and benefits, as well as priorities you and your family have.
Don’t sign up for something just because your banker suggests it, and ALWAYS understand what you’re agreeing to.