How Does Mortgage Protection Insurance Work?
What it is, how it works, how to get it, everything you need to know!
In an advanced world like today’s, we have insurance to protect us from any unfortunate tragedy that could occur. From keeping our car protected from a run in with a deer to making sure your neighbour slipping on the stairs of your new home does not put a dent in your pocket.
One such insurance policy is also a mortgage protection insurance.
What is Mortgage Protection Insurance?
Mortgage Protection Insurance, also known as MPI, typically serves as a type of life or disability insurance designed to protect your family from mortgage payments if you are no longer around to provide an income. Granted, for this to work you would have to be the primary breadwinner.
Moreover, the amount of the loan and the individual’s age and health is what determines the cost of the monthly premiums. In case a mortgage protection insurance is covering someone with a disability, the cost of their premiums will depend on the insured’s occupation.
Mortgage protection insurance can be similar to other types of life insurance such as term life insurance, in how it works. You buy a mortgage protection insurance policy and pay premiums until the term ends. In case you die before your term ends, your beneficiaries will receive a death benefit from your policy.
However, there are a few key differences in how a mortgage protection insurance policy works.
How Does Mortgage Protection Insurance Work?
Even though there is a death benefit in a mortgage protection insurance, the beneficiary is usually the mortgage lender or company. Which means if you die during the term of the policy, instead of your family getting the death benefit, it will directly go to your mortgage lender or company.
The death benefit also tends to decrease after the first five years of coverage in order to match your remaining mortgage payments since it is mainly used to pay off your mortgage balance. This is one main difference between mortgage protection insurance and other life insurance policies as the death benefit for other policies stays constant unless there are changes made to the original policy.
Moreover, the term length for term life insurance policies can be fairly flexible. You can choose a five year interval, a ten year or even a custom term length that some policies allow. However, mortgage protection insurance is always the same length as your mortgage is, fifteen years or thirty years. Your term length could also be limited by age. For example, State Farm’s term length for mortgage protection insurance is set at 15 years if you are above the age of 45. You can find a mortgage protection insurance calculator on any website to get free quotes until you find a policy that works for you and fits your needs better without messing up your budget.
Is Mortgage Protection Insurance Worth It?
If you are unable to get an affordable life insurance rate because of your poor health but still want to make sure you do not leave your loved ones behind with a burdensome mortgage payment, it might be the best option for you. It is a kind of no-medical exam policy that will prove beneficial for anyone in similar circumstances. Just make sure to look into mortgage protection insurance companies before signing up with your mortgage lender to make sure you are getting the best deal there is.
However, if you need life insurance that covers more than just your mortgage, a term life insurance policy may be the better option for you. It is more affordable than a mortgage protection insurance and provides more protection while allowing flexibility. Even if you are unable to get an affordable policy because of your health, you should always get a free quote just so you have an idea how competitive term life insurance rates can be.
Moreover, if you want to protect your home, at least while you’re alive, you could also look into homeowners insurance policy which will protect the structure of your home and attached properties even if you are still making mortgage payments. This way, you can protect your home for losses or damages because of homeowners coverage without losing your investment.
Mortgage Protection Insurance Benefits
Now let’s talk about the mortgage protection insurance benefits.
Mortgage is one of the biggest debts a person can have and if your family is receiving a death benefit lump sum of money, it might be overwhelming to figure out how you can allocate it appropriately. But mortgage protection insurance takes care of that for you. Since it is matched up to the mortgage balance and the money will go directly towards that, there is no worrying whether it will be enough to cover the remaining mortgage.
Just like with other types of loans, falling behind on your payments can seriously affect your credibility and you may even end up losing your home. And your mortgage protection insurance will continue making your monthly payments until your death benefit will run out if you die before then.
The policyholder will also have the benefit of avoiding the underwriting process. Since the health of the applicant determines the life insurance rates, no underwriting could mean higher insurance premiums. However, it can prove to be worth your while if your poor health conditions will raise the premiums of a standard term life insurance policy even more.
However, the main drawback of a mortgage protection insurance policy is the fact that it has a narrow scope. You could be covering mortgage payments but also, at the expense of your family’s other debts and bills. Whereas a regular term life insurance policy will cover mortgage as well as other expenses.
For anyone who is looking for affordable term life insurance options, mortgage protection insurance may not be the best idea for you.
The decreasing death benefit is also a drawback for mortgage protection insurance. Since the death benefit is linked to your mortgage balance, it would not give you much flexibility if things change in your life. Moreover, policies are typical level premium which means that you will continue paying the same for less as time goes on.
That’s not where the lack of flexibility ends. The coverage amounts, potential age restrictions and limited terms all lead to a strict policy that does not take into account the changes you and your family may go through during the term of the policy. Overall, the high cost of mortgage protection insurance is not worth the limited protection it provides.
Alternatives to Mortgage Protection Insurance
The most common alternative to mortgage protection insurance is the standard term life insurance policy. It’s the same as MIP in the sense that you pay for a policy for only a certain amount of time. However, it does not come with all the strings that a mortgage protection life insurance comes with.
With term life insurance, you can name a family member, loved one or institutions as beneficiaries whereas with mortgage protection insurance, all your death benefit goes to your mortgage lender.
Term life insurance will provide you with a tax-free, lump sum cash amount that you are free to use for whatever you need. You can choose to pay a mortgage with that amount, save it for retirement and college, pay everyday bills or pay off any other loans you might have.
Another alternative of permanent life insurances that last for the policyholder’s entire life instead of only being valid for a term period. All you have to do is make sure you pay your premiums.
However, these policies can be more expensive than mortgage protection insurance policies and even more expensive than a term life insurance policy. They also provide more coverage than what an average person needs as a financial backup. And of course, more coverage options mean more complications.
Mortgage Protection Life Insurance Riders
Since mortgage protection life insurance is a type of term life insurance, you can get many of the same features, also known as riders, as you would get with a traditional term life insurance policy. For example:
- Return of premium rider.
With this additional coverage feature, you will be refunded the sum of your premium payments. However, this would not include any applicable fees.
- Disability waiver of premium rider.
If you become disabled after buying the mortgage protection insurance policy, your premium payments will be temporarily waived until you have recovered.
However, these are not the only additional coverage riders you can get. Since mortgage protection insurance has limitations on the term length of the policy in order for it to better match with mortgage terms, you will not have the exact flexibility of a traditional term life insurance policy. However, you can either choose to add fifteen or thirty year riders if you wish to increase the term of your policy if that is what you need.
Difference between MPI and PMI
Mortgage protection insurance (MPI) is commonly also confused with another mortgage-related abbreviation for private mortgage insurance (PMI). Even though the names and abbreviations of both of these insurance policies are similar, they are distinctly different when it comes to their properties.
The main difference between the two is the fact that mortgage protection insurance aims to protect the insured whereas private mortgage insurance protects the lender from financial losses if you do not repay your load.
Why is private mortgage insurance paid then?
It is paid because it can help first time homebuyers qualify to receive a mortgage when they do not have enough to be able to make a downpayment of the loan amount. However, once you have made the down payment and your home value has increased to twenty percent equity, you will be able to ask your lender to remove private mortgage insurance from the mortgage. Even if you do not ask them, it is a requirement for lenders to terminate private mortgage insurance automatically once your loan balance has fallen below seventy eight percent of the home’s original value.
Choosing a Mortgage Protection Insurance Provider
As is the rule for any type of insurance, you should not settle on one mortgage lender without taking a good look at the market first. You should always shop around and evaluate the prices and features of mortgage protection insurance policies from various insurance companies so that you can fully understand what the policy does cover and what it does not. You can also check insurers’ financial health by researching the credit rating with the help from a global credit ratings agency for the insurance industry, AM Best.
Types of Mortgage Protection:
- Reducing Term Cover:
As you start paying off more of your mortgage, the amount your policy will be covering will reduce in line with the remaining balance of your mortgage. Under normal circumstances, the policy can also end once you have paid off the mortgage. This is also the cheapest form of mortgage protection. Your premium is not likely to change, although the level of cover can reduce.
- Level Term Policy:
The premium you have to pay and the amount you have been insured for remains the same for this type of mortgage protection insurance. However, this will give you the same amount of cover throughout the term of the mortgage. Moreover, if you happen to die before you have paid off your mortgage, the insurance company will pay out the amount you were originally insured for. This will pay off the mortgage and your estate will have any remaining balance.
- Serious Illness:
You can also choose to add a serious illness cover to your mortgage protection insurance policy which will make sure your mortgage will be paid off if you die or have been diagnosed or recovered from a serious illness that is already covered by your policy. This can be more expensive for you than other types of covers will be.
- Life Insurance Policy:
You can choose to use an existing life insurance policy but only if it is not already pledged or assigned to cover another loan or mortgage. It should also provide enough cover. Moreover, if there is any balance remaining after the mortgage has been paid off, your dependants will have the amount as a tax-free lump sum.
Where can you get Mortgage Protection Insurance?
There is not just one place you can get your mortgage protection insurance from. Here is a list of mortgage protection insurance providers you can get your policy from:
- Mortgage Lenders:
Mortgage lenders usually offer to arrange mortgage protection insurance for you at the same time you apply for a mortgage. This can be convenient for you as arranging your mortgage protection insurance through your lender will lead to easier payments of premiums. However, that does not mean you should not look around for a policy and only buy one from your mortgage lender. It is possible for you to find a cheaper insurance provider with better rates elsewhere which can prove to be even more convenient for you. So always shop around no matter how convenient you think buying insurance from an existing provider can be. You never know what you might find.
You can choose to use a mortgage broker who can help you arrange your mortgage protection insurance. A mortgage broker will help you compare several policies from various different providers in order to get you the best deal on your policy. Mortgage brokers will also make sure you are fully aware of any differences there might be between each coverage option. Since mortgage brokers usually work independently and not with any mortgage provider, they will have an unbiased perspective and will genuinely get you the best rates as it would not benefit them which policy you would choose since they would still get their commission.
- Existing Life Insurance Policy:
You can also choose to use an existing life insurance policy for mortgage protection insurance as well. However, you would have to make sure the amount you are insured for is at least equal to your mortgage value. Both the policies would also have to run for the same term. In order to do that, you would have to “assign” the policy to your lender which means you would agree to give the death benefit from your life insurance policy to your lender so they could use that amount to pay off your mortgage in case you die during the term of the mortgage protection insurance policy. If there is any policy benefit left over after paying off the mortgage, it would go to your dependents. However, your dependents will only get a cash lump sum if the mortgage is paid off and there is still some outstanding balance left over once you die.
If you want to leave some death benefit for your dependants, you will have to either take out a separate mortgage protection policy or you could choose to increase the level of cover on your existing life policy so that it provides more coverage and accumulates a larger death benefit that could take care of your dependants after your death.
What happens to the policy if you change your mortgage?
There are a number of things to consider when you are changing your mortgage. What happens to the policy depends on whether you are topping up your mortgage, extending it, switching or paying off the mortgage early.
- Topping up your mortgage:
When topping up your mortgage, you will have to make sure that your policy meets the new value of your mortgage. You could choose to get a new mortgage protection insurance policy for the total amount that your new mortgage is for or only for the top-up amount. However, you should compare the costs and the benefits of both the options before making a decision.
Keeping your original mortgage protection insurance policy may prove to be cheaper if you only buy the second policy for the top-up amount. You can check the amount you would have to pay in cancellation fees of the original policy and how much it is going to cost you to replace it with a policy for the full amount of your new mortgage.
Your premium may also be higher than the last time you took out coverage, whether you are topping up your mortgage or extending the term and getting a new policy. This is usually because you are older and your age will start affecting the premium. However, if you have made a significant lifestyle or health change like giving up smoking or if rates have decreased since the last time you applied for coverage, you may be able to get a cheaper cover option.
- Switching your mortgage:
The options available to you mostly depend whether or not you have your own policy or a group policy through your lender. If you have your own policy, you can choose to assign it to your new lender. This means your lender will become your beneficiary and will get the death benefit to pay off the mortgage in case of your death. The premiums and coverage will remain the same as before only if the amount you borrow and the term length of your mortgage does not change.
However, if you have a policy through your lender’s group scheme, your policy will be cancelled by your lender when you switch your mortgage to another provider.
Getting a new policy may cost you more as you will have aged since the last time you took out the policy, leading to higher premiums. Or if you have poor health conditions, you will have to pay higher premiums otherwise it might be difficult for you to get cover at all.
But before you switch your coverage, if your current mortgage protection policy is through your lender’s scheme, which means a group policy through your lender, you need to make sure you can actually get mortgage protection insurance.
So, the bottom line is, now that you know how does mortgage protection insurance work and if it is worth it, you can make an informed decision about whether or not it is the best option for you. If you think it might not be, you have other alternatives available such as term life insurance that you can explore which provide almost the same benefits.
However, if you think mortgage protection insurance is something that you need, you know what to do.