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How Mortgage Insurance Works
26 Sep 2019
Think about it - your mortgage is likely to be one of the biggest ongoing financial commitments of your life, if not the biggest of all. You might want to consider how you can protect yourself if one day you end up falling behind with your mortgage payments.
Missing a mortgage payment is a worry for homeowners as repossession is a bit of a nightmare scenario. That’s why some forms of insurance exist, such as mortgage protection insurance or income protection cover.
At LifeSearch, we offer mortgage protection insurance. It’s also sometimes referred to as mortgage life insurance, and it covers the remainder of the cost of your mortgage for the benefit of your dependents in the event of you passing away with some of the loan not yet fully repaid. So, when we talk about mortgage insurance, this is the product that we mean. Mortgage payment protection insurance (MPP) for example works differently, effectively being a form of income protection insurance - as we’ll explain more about later.
Level term vs decreasing term cover
One of the biggest differentiations that must be made when explaining how mortgage protection insurance works, is between level term cover and decreasing term cover.
In short, a level term mortgage protection policy offers the same amount of cover throughout the entire duration of the plan. If you take out this kind of policy, you’ll be able to set the size of the payout from the outset, and this payout figure will remain the same whether you are just a year into the policy, or a year away from the end.
For instance, if you take out a level term policy for a £200,000 mortgage, and decide to choose this same figure as the amount that would be paid out to your dependants should you pass away during the policy term, this is the amount that would be paid out regardless of timing.
So even if you were a year away from paying off the rest of your mortgage and passed away, your family would still receive a full £200,000, with the remainder of the money able to be used as they wished. There are factors that could affect the final payout amount, such as inheritance tax and delays via probate and ways you can mitigate against that such as putting your policy into a trust - which is usually free.
This differs from the situation with a decreasing term policy, which gradually reduces the level of cover provided over time, in acknowledgement of the fact that if you have a repayment mortgage, the total remaining amount to be paid off will also decrease with each repayment you make.
This means that if you died just one year into a 25-year mortgage, such a policy could pay your dependants an amount equivalent to almost the entire mortgage. However, if you were to instead pass away 24 years into that same mortgage, your relatives would likely only receive a payout equivalent to the final year’s mortgage amount still needing to be repaid. This is reflected in a cheaper monthly premium when compared to a level term policy.
What else do you need to think about when comparing policies?
As you might imagine, decreasing term mortgage protection insurance is cheaper than level term. However, there are other aspects of how mortgage insurance works that are likely to influence your ultimate choice of policy.
For one thing, the fact that mortgage protection cover – or mortgage life insurance – pays out only if you die, means it may be of little use to you if you are a single person with no dependants. If this is your status, even in the event of you passing while you are still in the process of paying off the mortgage, the house could simply be sold to cover the cost of whatever is left of the mortgage.
If that sounds like you, you would be better off with mortgage payment protection insurance, which is sometimes referred to as MPPI or mortgage payment insurance. This is the type of mortgage insurance that pays out if the policyholder is left out of work – as a result of injury or illness, for example. If you’re single, that’s likely to be the only time that you really need to worry about your mortgage being paid. However, that said - it may make better sense to look at a separate income protection policy, which can cover you for a set monthly amount over and above your mortgage payment to help take care of the other bills, and living costs - not just the mortgage payment.
Need advice? We can advise on and provide a quote for mortgage protection insurance or an income protection plan.
If you’re unsure as to which insurance product might be best for you, we can give you the right guidance.
Fill in and submit our online contact form or give us a call on 0800 316 7253 for a friendly chat about your options.
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