For most homeowners, their mortgage is their biggest financial commitment. It makes sense, therefore, to ensure that if you were unable to continue paying your mortgage instalments each month, you or your family would be able to pay off the mortgage and stay in your home.
There are various types of insurance products available to help you if you are unable to keep up with mortgage payments, whether through sickness, death, or other circumstances. Mortgage payment protection insurance (MPPI) usually only covers your mortgage repayments for a year – if you’re jobless or ill for a long time, for example – while mortgage life insurance covers the entire cost of your mortgage. This guide focuses on mortgage life insurance.
How does mortgage life insurance work?
There are two types of mortgage life insurance – level term insurance and decreasing term insurance. These are both purely insurance products: if you or a dependant makes a claim, the policy ends. If you pay into the plan and never need to make a claim, you won’t get anything back at the end of the term.
Level term insurance
Level term insurance means that you choose the size of the pay-out – £200,000, for example – which could be used to pay off the mortgage and/or cover other household bills. If you were to die, your family would receive the lump sum and the policy would finish.
Decreasing term insurance
Decreasing term insurance is intended to cover a debt that is reducing. If you have a mortgage based on repaying interest and capital then the amount you owe to your lender should fall over time.
Your pay out would also fall, reflecting the reduction in your liability. It’s a cheaper form of insurance than level term insurance, but it does mean that towards the end of the policy’s life the potential pay out would be much smaller than at the beginning.
Critical illness cover
Some mortgage life insurance policies will let you add critical illness cover. The younger you are when you arrange the policy, the cheaper it will be. As you get older, it can become very expensive to arrange critical illness cover.
Critical illness cover pays out a lump sum if you are diagnosed with a serious or life-threatening condition, like cancer, heart attack, dementia or a stroke. However, it is important to read the small print as some conditions are not covered and the illnesses that are covered differ between providers.
Who needs mortgage life insurance?
“If you are a single person with no dependants then you may not need it,” says Mark Homer, a mortgage and property expert and founder of Progressive Property. “It is designed so that if one of the borrowers dies, the mortgage will be paid off.”
It’s useful for people who are married, in a civil partnership, or are cohabiting and could not afford the mortgage repayments with a single income. It is also useful for anyone with dependants, whether that is children, elderly relatives, or anyone else who relies on you or who shares your home with you.
Homer says that buying level term insurance is helpful, even if you have a mortgage debt that is decreasing, rather than opting for decreasing term insurance.
“The lump sum would pay off the mortgage, or be used for other expenses, in the event of your death,” he says. “You could cover a sum equivalent to the whole of the outstanding mortgage.
“If you are a single person with no dependants then critical illness cover could be useful, as it could help you if you were unable to work due to illness.”
If you have a buy to let mortgage you don’t necessarily need insurance, as the mortgage is paid by the tenant, even if you are ill. If you were to die, the property would have to be sold or remortgaged anyway.
How long should a mortgage life insurance policy last?
When you are choosing the term of the mortgage life insurance policy, you might decide to time it to end when your mortgage term ends. However, Homer suggests a smarter plan would be to take out cover for as long as possible,
“You might have a mortgage term of 20 or 25 years, by which time you might have paid the mortgage off,” he says. “If you are young and you take a policy out for 30 years then it will cost more per month, but over a longer period you will end up having something which is cheap. That’s because as you get older you are likely to pick up medical conditions and you have got to disclose all pre-existing conditions.”
If you want to take out life insurance later in life, or at the end of your mortgage term, you may have to have a full medical exam and blood tests, he explains.
“As you get older you are more likely to have special terms imposed and higher premiums. I would opt for level term insurance even if the mortgage debt is going down. Think of it as cover not just for the mortgage but for other expenses or bills as well.”
He recommends that you get the mortgage life insurance written into trust. This means that any pay out your family receives won’t be treated as part of your estate for inheritance tax purposes. As inheritance tax for an individual now applies on sums above £325,000, he says this is important for many people who may not even have thought they could be liable for inheritance tax.