There are many consider when purchasing a new home.
From selecting the perfect home that matches your lifestyle, to ensuring the new location is not too far from your works. Aside from making sure the backyard is large enough for summer barbecues, insurance is an important consideration.
If you're like most people, you'll need a mortgage to purchase your new home. However, keep in mind that a mortgage is an expensive contractual obligation, and life is unpredictable. If something were to happen to you, your mortgage would not simply go away.
Will your family be able to pay a large mortgage payment each month after you die? This is where mortgage life insurance can help. It protects your family by repaying the lender the amount you owed at the time of your death.
Let's look at what mortgage life insurance is, how much it costs, and what other options are available.
What is mortgage life insurance?
Mortgage life insurance, also referred to as mortgage protection insurance, protects your family by paying off the balance on your mortgage when you pass. With a mortgage life insurance policy, you will not have to worry about how your family will keep up with the monthly mortgage payments after you are gone.
Mortgage life insurance is essentially term life insurance with a twist. The term of your policy corresponds to the number of years remaining on your mortgage contract. If you have 15 years left on your mortgage, your mortgage life insurance policy only covers you for that amount of time. Your mortgage life insurance coverage, like term life insurance, will expire if you outlive the term (15 years in this case).
As with term life insurance, mortgage life insurance might not be available after a certain age. For instance, some lenders offer 30-year mortgage life insurance only to applicants aged 45 or less.
The following aspects, however, are unique to mortgage life insurance:
- You do not get to pick the policy beneficiary. The mortgage lender is the beneficiary default, and you can neither revoke the beneficiary designation nor update it. Upon your death, the insurer pays the death benefit directly to the lender. In effect, your dependents benefit indirectly from the policy. Instead of handing over the death benefit to them, the policy leaves your family a mortgage-free home.
- The policy offers a declining payout. At any given point in time, the payout is exactly the same as the balance left on your home loan. As you make mortgage payments, the home loan balance will decline, and so will the death benefit of your mortgage life insurance. However, the monthly premium amount remains the same.
How much does mortgage life insurance cost?
How much you pay for mortgage life insurance depends on your provider, age, and mortgage balance when you apply for coverage. Mortgage life insurance gets more expensive with age, so you will pay more at age 50 than at age 40. Likewise, the higher the mortgage amount, the more you will pay in premiums.
Cost of mortgage life insurance vs. term life insurance
Term life insurance is fully-underwritten (involving both a medical examination and health questionnaire), while mortgage life insurance is not. The insurer takes on more risk in the case of mortgage life insurance, which it passes on to you by increasing your premiums. For people in reasonably good shape, mortgage life insurance usually costs almost twice as much as a comparable term life insurance plan after they cross 30.
What is the difference between mortgage life insurance and mortgage default insurance?
Mortgage default insurance, unlike mortgage life insurance, is mandatory if you put less than 20% down on a home purchase. For instance, if your home costs $600,000 and you put 12% down (that is $72,000), you will have to buy mortgage default insurance.
Mortgage default insurance is designed to protect your lender in case you ever default on the loan. It will use the policy to cover losses related to foreclosure.
If you default, the lender will take action to recover the money you owe. That generally entails selling your home. If your property sells for less than the mortgage balance, the mortgage default insurance will cover the difference.
For example, let us say you took a home loan of $500,000 but were unable to pay the monthly installments after a year. To recover its money, the lender sells your house, but the sale yields $60,000 less than what you owed. In this scenario, the mortgage default insurance provider will chip in and pay your lender the remaining $60,000.
Here is a quick run-down on the main differences between mortgage life insurance and mortgage default insurance.
What does mortgage protection insurance cover?
Your mortgage payments are covered by a mortgage life insurance policy. Your policy will only pay out if you die before your mortgage is paid off. The proceeds of the policy are paid directly to the lender, but your family will not have to worry about making the remaining mortgage payments.
In comparison to other life insurance products that pay the death benefit to those you choose, mortgage life insurance protects your dependents indirectly.
How much mortgage insurance do I need?
Your coverage should be enough to pay off the balance on your mortgage. For example, if you currently owe $600,000 to the lender, the initial policy amount should be $600,000. Anything less, and your family will have to pay a portion of the remaining mortgage balance out-of-pocket. As you make mortgage payments, the death benefit will become smaller overtime.
What is the difference between mortgage life insurance and life insurance?
Mortgage life insurance and life insurance are two very different financial products, as highlighted by the chart below.
Are there any other ways of protecting a mortgage?
Many Canadians' most valuable asset is their home. Fortunately, mortgage life insurance is not the only tool available to ensure that your family will not be burdened by an expensive mortgage after your death. Term life insurance, disability insurance, and critical illness insurance are also options. Term life insurance is usually the best option out of the three.
If you are unable to work due to illness or injury, disability insurance will provide you with a regular income. You can spend the money however you want, including on mortgage payments.
Critical illness insurance, like disability insurance, protects not only your home loan but also your earning capacity. It pays a one-time lump sum rather than monthly payments. If you are diagnosed with a covered illness, you are eligible for a payout.
In contrast to the previous two insurance products, term life insurance pays a cash benefit upon your death. It can perform the same functions as mortgage life insurance at a lower cost and without any of its limitations.
Here are some of the main reasons why term life insurance is a superior tool for protecting your mortgage:
- Considerably lower rates
If your health is reasonably good, you will always get cheaper rates with traditional term life insurance compared to mortgage life insurance.
Term life insurance involves a medical exam. The results of your paramedical exam, along with your medical history and answers to the health questionnaire included with the application form, allow the insurer to get a clear picture of your health. As a result, the insurance carrier is able to accurately assess your risk level, which translates into lower rates if you are in decent shape.
Mortgage life insurance policies, in contrast, are not fully-underwritten. Because the insurer has incomplete information regarding your health, it is taking on more risk by extending you coverage. It passes the extra risk on to you in the form of higher premiums.
- More coverage
Term life insurance is tied to you, not your mortgage. You can buy as much term life insurance as you reasonably need and can afford. Whereas, the mortgage insurance coverage usually does not exceed the amount owed to the lender.
- Level death benefit
With term life insurance, the death benefit does not change. Your family will receive the same amount whether you die two years, five years, or 10 years into the policy. In contrast, mortgage life insurance provides a diminishing payout. The death benefit reduces annually to match the remaining mortgage balance.
- Your family can use the payout as they want
Mortgage life insurance pays the death benefit directly to your lender. No money is passed on to your family.
In the case of term life, you can nominate your loved ones as beneficiaries, and they are free to spend the payout as they deem fit. They can repay the home loan if that is their top priority. But if other needs, like education costs, are more pressing, they can choose to address them first.
- You pick the beneficiary
Term life insurance lets you decide who will receive the payout after you pass.
- Option to extend the term
Generally, term life insurance contracts include a guaranteed renewability feature, which means the insurer cannot turn down your request for coverage renewal as long as you meet the age criterion. Also, nor can it ask you to submit proof of good health.
However, a mortgage life insurance policy only lasts as long as you have an outstanding debt on the mortgage.
What are the biggest limitations of mortgage life insurance?
One of the biggest limitations of mortgage life insurance is that the payout decreases as time goes by but the monthly premium does not change. Another drawback is that you are locked into paying off the lender, even if your family’s priority changes later. For instance, they may prefer to sell the house instead of paying off the mortgage or keep paying the monthly mortgage payments and invest the lump-sum insurance payout.
Your mortgage will not follow you to the grave, nor will it simply vanish. If you pass away with a mortgage balance, your heirs will be required to repay the loan. Otherwise, the lender may forcibly sell your home to recoup the debt. You can avoid passing on your mortgage to your spouse or dependent children by insuring it with a product such as mortgage life insurance or term life insurance.
Unlike term life insurance, mortgage life insurance only covers your mortgage and pays directly to the lender. It is significantly more expensive than term life insurance, but you can qualify even if you have a serious underlying condition.
The cost of mortgage life insurance is largely determined by your age and mortgage balance. Dundas Life, which works with top Canadian insurers, can get you the best rates, giving you peace of mind that if you die unexpectedly, your family will not lose their home. Reach out to a licensed broker and find the best rates today.
Frequently Asked Questions
Is term life insurance a better option than mortgage life insurance for covering a mortgage?
For most people, term life insurance is a better option. It is cheaper, offers greater flexibility, and is usually renewable. It can cover your mortgage payments, as well as other financial liabilities, like other debts and college tuition fee for your kids. If you have an underlying health condition that would make term life insurance very expensive, consider mortgage life insurance.
Is mortgage life insurance mandatory?
No, it is not. There is no law that states you must sign-up for mortgage life insurance when you take out a mortgage. However, protecting your mortgage is recommended, all the more so if you are the sole or primary earner in your family. Otherwise, your dependents may struggle to pay off the mortgage balance after they lose your income. Both term life insurance and mortgage life insurance can cover a mortgage, but the former is cheaper for most people and offers better flexibility.
When does buying mortgage life insurance make sense?
If you have an illness that makes traditional life insurance prohibitively costly or unattainable, mortgage life insurance can be a good fit. Let us take an example, Sharon from Manitoba is unable to obtain a traditional life insurance policy due to chronic asthma, but she wants to make sure her partner does not lose their home if she dies unexpectedly. As she is unable to qualify for standard life insurance, Sharon can consider mortgage life insurance.