Decreasing term life insurance is a kind of life policy where the payout amount gets smaller over time.
This type of insurance is helpful for people who want to use it to pay off their mortgage (which decreases overtime) or for business owners who want to keep their business safe.
How does decreasing term life insurance work?
Decreasing term life insurance is a type of temporary coverage that pays out less over time. However, your premium rate remains the same throughout the policy’s life.
Generally, people buy a decreasing-term life plan to provide coverage until they pay off a large debt, like a mortgage. As you repay the mortgage, the death benefit decreases. Each year the death benefit reduces by a certain percentage or fixed amount until the end of the policy term, by when you would have presumably paid off your mortgage.
Decreasing term life insurance is also known as mortgage insurance. You can purchase it directly from your mortgage lender or a life insurance company. Keep in mind where you buy the coverage matters.
When you buy it from an insurance broker, you get to pick the policy beneficiary (i.e. the person who gets the life insurance proceeds upon your death). If you purchase it as part of your home loan, usually the mortgage lender is listed as the sole beneficiary and you do not have the right to change the beneficiary designation.
Here is an example of how decreasing term life insurance works:
Joe has recently purchased a house, for which he took a 20-year mortgage of $300,000. He also bought a decreasing term life policy to cover the mortgage and listed his wife, Lucy, as the beneficiary. Now if something were to happen to him, his wife will be able to comfortably repay the loan.
If Joe passes in the first year, Lucy will receive the entire death benefit (i.e. $300,000). But if he passes in the second year, the payout Lucy receives will be $285,000. Every year, the payout will decrease by $15,000 until the end of the 20-year term expires.
Decreasing Term vs. Level Term Life Insurance
Both level-term and decreasing-term life insurance provide temporary coverage and have level premiums. However, the similarities end there. With a level term policy, the death benefit does not change throughout the policy’s life.
Continuing with the example above, Lucy would have got the full $300,000 payout had Joe bought a term life plan with a level benefit and died two years later. In contrast, with decreasing term insurance, the amount of money the insurer pays to the beneficiary gets less and less as time passes.
What are the pros and cons of decreasing term life?
Like any other financial tool, decreasing term life insurance offers unique benefits but is not without a few drawbacks. Knowing its pros and cons can help you make an informed decision regarding whether it is right for you.
The main attraction of decreasing term life insurance is its affordability. Because the amount it pays out goes down each year, decreasing term plans are much cheaper than level-term life policies.
Decreasing term life insurance plans are often used to help pay off business loans, house loans, or personal loans. The money that gets paid out if someone dies follows the same schedule as the repayment plan for the loan. In other words, your policy’s value will gradually reduce over the policy term, along similar lines to the reduction of your debt.
Decreasing term life insurance may not be the best choice for those who need life insurance to support their family with money if they were to pass away. This is because the amount of money paid out gets smaller over time, so it might not be enough to help your family in the future.
Trying to save a bit of money each month by choosing this type of insurance might risk your family's financial security if something unexpected happens down the line.
Who should buy decreasing term life insurance?
A decreasing term plan may be a good choice if:
- You need life insurance only for your mortgage.
You can match the death benefit to the amortization schedule of your home loan so that at any given point in time the death benefit will be equivalent to the balance on your loan. Should the unthinkable happen, your surviving spouse can use the death benefit to repay the lender.
- You are sure your financial obligations will go down over time.
Aside from covering debt payments, you may opt for a decreasing term life plan if your financial obligations will become less as time passes. For example, with your kids all set to complete college, you may need less protection over the next decade.
- You are a small business owner.
A decreasing term policy can be a cost-effective way to protect your business against debts, like operational expenses and startup costs. It may also make it easier to secure a business loan, as lenders are likely to ask you for collateral. Lastly, such a policy can protect a surviving business partner, who can use the payout to pay off the remaining debt for which the deceased partner was responsible.
What is the cost of decreasing term life insurance?
Decreasing term policies are more affordable than term life plans with a level death benefit because the benefit amount reduces each year. How much you will pay for decreasing term coverage depends on loads of factors, such as:
As a general rule, the cost of life insurance goes up with age. This is based on the assumption that as you get older, your policy is more likely to outlive you than the other way around.
Health and Lifestyle
You’ll need to share your medical history when you apply. A pre-existing condition could lead to higher rates. You will also likely pay more if your Body Mass Index (BMI) isn’t within a healthy range or if you smoke.
Family medical history
The insurer will evaluate your family health history before setting your rate. If you are found to be genetically predisposed to certain critical illnesses, like heart disease, your cost of insurance will go up.
If you have an occupation that could be considered high-risk, you will pay more for coverage. A dangerous hobby, such as skydiving or bungee jumping, will also lead to higher premiums.
Policy specific details
The higher the sum insured, the more you will pay for your premiums. Similarly, the longer the policy term, the higher the premium rate.
How to choose the best decreasing term insurance?
When shopping for decreasing term life insurance, keep in mind the following two tips:
- Make sure the term and the death benefit of your policy mirror the term and size of your loan. Let’s say you have a $500,000 mortgage that you must pay over 30 years.
- If you want life insurance to cover this debt, ensure your decreasing term insurance provides coverage for at least 30 years and starts with a face amount of $500,000. Also, ensure that the death benefit reduces along similar lines to the reduction in your mortgage as you pay it off.
- Shop around to get the best rate. Since policies with similar coverage at different insurers can vary widely in premiums, comparing rates is the only way to ensure you won’t be paying any more than you have to.
Decreasing term life insurance is a type of life insurance coverage that pays out less over time, though the premiums remain the same throughout. You may want to consider it if you want to cover a mortgage or are a small business owner and want to protect your business. But if you have dependents or if your financial obligations are not expected to reduce with time, consider a level term life policy instead.
Unable to make up your mind between decreasing term and level term? Let Dundas Life help you. Drop us an email or have us call you and our experts will provide you recommendations based on the information shared by you. We will also help you find the best life insurance coverage in Canada (be it a decreasing term or level term policy) at a great price.
Frequently Asked Questions
What happens at the end of a decreasing life insurance policy?
With a decreasing term policy, the death benefit gradually decreases over time until it reaches $0, at which point the coverage expires. Generally, the death benefit reaches $0 on the date your loan is due to be repaid in full. In other words, your beneficiary would receive more money if you died near the start of the policy term than closer to the policy’s expiry date.
What happens to my term life insurance if the term runs out?
Term life insurance provides coverage for a predetermined period. This period could be as short as one year or as long as 30 or even 35 years. As your policy approaches the end of its term, you have three options:
- Renew coverage (Doesn’t require a new medical exam, but your premium rate will go up on account of you being now older than when you first took the policy)
- Convert to permanent life insurance (No proof of good health is needed, but the premium rate will increase since permanent life insurance is more expensive than term life)
- Let the policy lapse (If you do not renew or convert, your policy will automatically lapse once its term is up)
Is decreasing term insurance worth it?
Due to its affordability, decreasing term life insurance is an option if you need life insurance to cover only your debts. However, if someone depends on you for their financial well-being, you may be better off with a level term life plan. Your family could use the death benefit to cover a number of expenses, including mortgage payments, food, education, and unforeseen financial troubles.