What would happen if you were to pass away before the mortgage on your home is paid off? Will your loved ones have enough money to keep current on the loan?
One option is mortgage protection insurance, also called mortgage life insurance, which pays off your mortgage in the event of your passing. Mortgage protection insurance isn’t right for everyone, however, so it’s important to weigh the pros and cons carefully, and understand how this type of policy contrasts with other kinds of insurance.
What does mortgage protection insurance do?
Mortgage protection or mortgage life insurance is a form of life insurance that’s designed to pay off your mortgage debt in the event you pass away before the balance is paid in full.
“Typically, mortgage protection insurance is sold as an option after closing on your home,” explains Herb Dorow, an agent with Maris Brown Insurance Group in Rochester Hills, Michigan. “The life insurance amount of the policy is tied to your mortgage amount. As your mortgage amount decreases, so does the benefit, but the premium does not decrease.”
Say, for instance, you take out a mortgage loan for $300,000 at 3.1 percent interest over 30 years to buy a home. You could purchase a mortgage protection or mortgage life insurance policy for the same term – 30 years – with a face value of $300,000.
Now, assume you pass away 10 years after taking out the loan and insurance policy, leaving behind a roughly $228,000 unpaid mortgage balance. In this case, your mortgage protection or mortgage life insurance policy would pay off the $228,000 balance in full.
“Traditionally, when someone takes out a mortgage protection policy, they are trying to cover the amount of the mortgage for the period they are set up to pay on the mortgage,” says Tyler Rees, owner of Innovative Financial Group in Wilmington, North Carolina.
Mortgage protection insurance is usually costlier than life insurance — but still relatively inexpensive, at about $100 or less a month — and sold by mortgage companies, banks or independent insurance companies.
“Each policy will be priced based on age, sex, location, amount of the mortgage and term of the mortgage,” says J. Keith Baker, chair of curriculum for Mortgage Banking at Dallas College in Irving, Texas. “A healthy 25-year-old man living in Indiana would probably pay as little as $26.45 a month for $100,000 worth of coverage on a 30-year mortgage.”
That’s a lot more than that same person can expect to pay for a 30-year term insurance policy with $100,000 worth of coverage. In this case, the policyholder could pay as little as $13.85 a month, according to Baker, citing a Transamerica online premium estimator.
Life insurance vs. mortgage protection insurance vs. PMI
While mortgage protection insurance is considered a form of life insurance, it differs from traditional life insurance and also from private mortgage insurance, or PMI.
Unlike term or whole/permanent life insurance, mortgage protection insurance involves minimal to no underwriting, which makes it easier to qualify for.
“You don’t need to undergo a medical exam to get coverage,” Baker notes.
Additionally, with life insurance, your beneficiaries receive a lump-sum cash benefit upon your death. The payout for mortgage protection insurance, on the other hand, goes directly toward paying off your mortgage; the money can’t be used by your beneficiaries for any other purpose.
“With traditional term or permanent life insurance, the amount of coverage does not decrease and you control the policy,” Dorow says. “Most term policies allow you to convert some or all of the benefit to permanent insurance later. The premiums do not change for the selected period of coverage, and you can purchase coverage that exceeds just your mortgage amount.”
Don’t confuse mortgage protection insurance with private mortgage insurance, or PMI, either. The latter is a policy that’s designed to protect your mortgage lender in the event you default on your loan payments. It’s usually required on conventional loans if your down payment is less than 20 percent of the home’s purchase price. Put another way, while you’re obligated to pay PMI (if required), you receive no benefit from it.
“Where mortgage protection insurance is a policy that protects the homeowner, private mortgage insurance protects the bank,” Rees says.
Who should get mortgage protection insurance?
Mortgage protection insurance can make sense for the right candidate. If you’re considered risky to a life insurance company, for example, mortgage protection insurance may be a cheaper and more viable option.
“It can be somewhat more competitive for someone age 50 to 60 years old who has some health issues that may make purchasing a standard life insurance policy difficult or more expensive,” Baker says. “Also, folks with dangerous professions who cannot get reasonable cost coverage, like a race car driver or skydiving instructor, should consider this insurance.”