Know the difference: Which insurance products you can use to cover your mortgage

Mortgage life vs. PMI vs. Payment Protection vs. Level Term vs. Whole Life - Which of these insurance products can you use to cover your mortgage?

To the uninitiated, life insurance is basically something that pays the beneficiaries when you die. Life insurance has long since evolved and became a somewhat more complicated creature. Insurance products now run a gamut of benefits and features aimed towards meeting the needs of various individuals. The same goes for your mortgage. There are a number of insurance products that can help protect your mortgage.

Let’s take a look at the different life insurance products you can use to cover your mortgage and consider the distinctions:

Mortgage Life Insurance

This will pay to cover the remaining debt on your mortgage upon your death. The most common type of mortgage life insurance is a decreasing term life coverage, which is designed to decrease the coverage amount as you pay off your loan. There is an option to get mortgage life insurance with critical illness cover. The critical illness will pay out in the event that you are diagnosed with a critical illness.

Why you need it: Mortgage life insurance ensures that the mortgage is paid off if you die (or get critically ill, if this is available). Learn more about when and why you will need mortgage life cover.

Pros of Mortgage Life Insurance

• Lower premiums since this is a decreasing life insurance policy.
• Ensures that the family keeps the property since the lender is the designated beneficiary.
• It’s easier to obtain coverage since underwriting is not as stringent compared to the underwriting policies covering life policies issued on an individual basis.

Cons of Mortgage Life Insurance

• Same premium rates applied to healthy applicants and unhealthy applications (except when there are “yes” answers to some health questions).
• Pays only for the mortgage and not for the family’s other needs
• If this is a decreasing cover, the insurance may not be enough to pay off the actual loan if higher interest rates are used in the mortgage loan than that which is used to compute for the decreasing cover.

Private Mortgage Insurance (PMI)

Although it also has the words “mortgage insurance”, this is primarily an insurance to cover the interests of the lender on your loan. When you default on your mortgage payment for whatever reason (death, unemployment, sickness), mortgage insurance will pay the lender the remaining amount of the debt. This is different from mortgage life insurance. Read more about the comparison between the two types of insurance.

Why you need it: Private Mortgage Insurance is required if you only pay the minimum down payment on the property.

Pros of PMI:

• Facilitates loan approval for lower down payment amounts. If you can’t afford to put in a down payment of at least 15 to 20% on the home, getting PMI cover can help you close the mortgage.
• Has the option of getting this from the lender (which makes payment more convenient) or from a provider of your choice (which may provide lower premium quotes).
• Has the option of cancelling the cover once the unpaid balance is below 80% of the total purchase price.

Cons of PMI:

• Payment of the insurance does not mean you are free and clear of your obligations. The insurance company may initiate recovery procedures against you in an effort to recover the money they pain to the lenders.
• Premiums are not tax deductible.
• Extra costs. If you want to get rid of the PMI cover, you may need to pay for the appraisal, which can be over £300.

Mortgage Payment Protection Insurance

This covers the mortgage payment in the event that you cannot earn an income because you got sick, injured or unemployed. The payments from are limited to a number of months, or until the Insured Person is able to earn an income, whichever comes first.

Why you need it: If you are concerned about sickness, accident or unemployment, this will help tide you over as you try to get back on your feet and regain earning an income.

Pros of MPPI

• Covers a wider range of eventualities, not just death or critical illness.
• Pays for the mortgage payments while you are recovering from your illness or injuries or are looking for a job
• Monthly payments may be more than the monthly mortgage payments, enabling you to pay other monthly bills as well.

Cons of MPPI

• Has a waiting period where you will need to make the payments before the insurance will kick in.
• Has a maximum benefit limit on the monthly payments.
• Limited payment period which means that you will need to find a way to pay the mortgage when the payment period ends.

Level Term Insurance

This is a life insurance product that provides you with the same policy amount for the duration of the policy. This can also be used to cover your mortgage (as well as other things) when you die. Term insurance means that you pay cheaper premiums but don’t stand to receive anything when the policy contract expires.

Why you need it: Read our article about term life insurance to see what it provides and how it differs from mortgage life cover.

Pros of Term Life Insurance

• Depending on the amount of cover, may be able to pay not just the mortgage but also some of the family’s other needs.
• The family has the freedom to use the proceeds from the life insurance according to their discretion.
• More affordable premiums, compared to whole life insurance.

Cons of Term Life Insurance

• Temporary cover only. The cover is up to a certain number of years. If the Person Insured dies after the coverage period, there will be no payments forthcoming.
• The level amount of insurance does not account for inflation.
• The flexibility in using the proceeds may also be a disadvantage since the beneficiaries may decide not to cover the mortgage payments.

Whole Life Insurance

This is a permanent life insurance policy. It accrues cash values over time and this cash value earns interest that can be used to pay for future premiums, get a paid-up policy (where premiums are all paid up for a smaller amount of coverage) or withdrawn as cash. A whole life insurance policy will provide cover for one’s lifetime.

Why you need it: Whole life insurance policy provides long-term coverage where the proceeds can be used for the Person Insured’s end of life expenses. The proceeds may also be used to pay up the mortgage.

Pros of Whole Life Insurance

• Provides long-term cover so that the Person Insured does not have to worry about outliving the policy
• Increases in the expected proceeds due to growing cash values
• Cash values earn interest tax-free
• The family has the freedom to use the proceeds from the life insurance according to their discretion.

Cons of Whole Life Insurance

• More expensive. Since this provides cash values, the premiums are considerably higher than mortgage life insurance or term life insurance.
• More difficult to get. Those who are not in good health may expect premium ratings. The same goes for one who has a hazardous occupation.
• The flexibility in using the proceeds may also be a disadvantage since the beneficiaries may decide not to cover the mortgage payments.

Latest update: 16.06.2013

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Other sites: critical illness cover, lifeassurance.org.