What's the Best Insurance to Protect Your Ability to Pay a Mortgage?
If you're like most homeowners, your mortgage payment is the biggest expense you face each month. Because of this, an insurance policy designed to cover these payments should you be unable to make them might sound like a smart financial investment. But be careful: Mortgage protection insurance isn't always worth your money.
Mortgage protection insurance is a form of life insurance usually offered to consumers shortly after they take out a mortgage loan. This type of insurance can vary depending on the insurer offering it, but usually a policy will cover your mortgage payments if you lose your job or suffer a disability. It might also pay off the remaining balance of your mortgage loan when you die, meaning that your surviving spouse or partner can live in the home without worrying about a monthly mortgage payment.
Tammi Lindley, senior loan officer with Mortgage Express in Portland, Oregon, doesn’t doubt that it could prove challenging for homeowners to make their mortgage payments should they become disabled or unemployed. This is especially true if it's the primary breadwinner who is no longer working.
Lindley, though, recommends that homeowners protect themselves with a traditional disability insurance policy that is not tied directly to their mortgages instead of a mortgage protection policy. A disability policy will pay out in cash should an injury keep you from working.
Depending on the policy, these cash payments might cover more expenses than just the mortgage payment, Lindley says. A disability payout, for example, might help homeowners also cover utilities and the other monthly expenses of living in a home.
And that death benefit? A traditional life insurance policy might be a better choice, too. When you die, the payout of your life insurance policy will kick in, and your dependents can use that money to pay off whatever you owe on your mortgage. They can also use that money to pay for any other expenses.
"Having a policy in place to protect the homeowner is advisable," Lindley says. "Working with an insurance agent to find the right fit for their needs and budget can provide peace of mind during a stressful life event."
Rarely is mortgage protection insurance the best choice
Is there ever a time when mortgage protection insurance makes sense? Maybe, depending on your health or profession. Maybe you have health conditions that makes traditional life or disability insurance too expensive. Or maybe you work in a dangerous profession that does the same. Mortgage protection insurance might be an option.
Matt Schmidt, diabetes life insurance advisor and chief executive officer of Diabetes Life Solutions, said that the concept behind mortgage protection insurance is a good one: An insurance policy that makes payments for you could be a way to hold onto your house should you suffer a job loss or disability.
The problem? The mortgage protection insurance policies offered by most banks and lenders are too expensive and usually benefit mortgage lenders, not homeowners, Schmidt says.
"The products that banks and lenders offer consumers are usually not in their best interest."
Mortgage insurance protection policies are basically simplified forms of life insurance that don't require medical exams. This makes it easy to qualify for these policies. But because medical exams aren't required, they are usually more expensive than traditional life insurance policies, Schmidt said.
"The only time a person should take out a mortgage insurance policy is if their health is below average," Schmidt says. "If this policy is the only one you'd medically qualify for, then we'd recommend this avenue."
Problems with mortgage protection insurance
The biggest problem with mortgage protection insurance? It really protects your mortgage lender, not you. If you die and you still owe on your mortgage, the insurer behind most of these policies will send a payment to your lender, not to your survivors.
Yes, this does mean your partner or dependents will now have a home that doesn't come with a hefty mortgage payment. But if you relied on a standard life insurance policy instead, your dependents would receive the payout from your policy directly. They could then have used that payout to pay off what you owed on your mortgage if they chose. And if there was any money left over, they could have used it for whatever other purpose they chose.
Say you lose your job or suffer a disability that keeps you from making your mortgage payment. Again, your insurer will send payments directly to your mortgage company, not to you. And your policy will usually only cover mortgage payments for a set period, often one or two years.
These policies also only pay the principal and interest portion of your monthly mortgage payment. You'll still be liable for your property taxes and homeowners’ insurance.
Mortgage protection insurance comes with a final drawback: It's what's known as a declining-benefit policy. As you pay down your mortgage, the potential payout from your policy shrinks, but your premium remains the same. The longer you hold onto your policy, the less it is worth.
If you’re a savvy shopper, you might be able to find a better form of mortgage protection insurance. Some companies offer programs that pay dependents whom you name instead of your mortgage lender. You might also be able to negotiate a set death benefit with these policies. Say you owe $200,000 on your mortgage when you take out your policy. Some companies might agree to payout the full $200,000 when you die even if you’ve paid your mortgage down to, say, $60,000.
Taking out mortgage protection insurance policies without these features — and they aren’t commonly offered — is almost always a waste of money.
Jonathan Holloway, life insurance agent and co-founder at Atlanta-based NoExam.com, said that consumers are right to draft a plan to protect themselves and their family if they can no longer make their mortgage payments.
But Holloway says that a mortgage protection policy might not be the best way for homeowners to do this. A standard term life insurance policy, he said, could offer the same protection at more affordable premiums. Homeowners might not even need to rely on a separate disability insurance policy.
How? Consumers can add a waiver of premium and disability income rider to their life insurance policy. This would eliminate policy premiums and provide a stream of income should policyholders become permanently disabled. Policyholders can then use part of this income to make their mortgage payments.
Insurance laddering can help with mortgages
Holloway said that a concept known as insurance laddering can help homeowners cover mortgage payments while paying as little as possible in premiums. Basically, you'd take out several life insurance policies, all with that waiver of premium and disability income rider, of different term lengths and coverage amounts.
For instance, you might take out a 10-year term life insurance policy that provides $500,000 worth of coverage, a 20-year term policy with $300,000 worth of coverage and a 30-year term policy with $150,000 worth of coverage.
You will no longer pay a premium on the 10-year policy after 10 years pass. After 20 years, you'd no longer pay a premium on the 20-year policy. The amount of coverage you have, then, declines as your get older and your life insurance needs decrease. At the same time, the amount you pay each year for life insurance will also decline as your shorter-term policies expire.
This ensures that not only do you have life insurance protection, but that you have the most coverage when you are younger and need it the most and the least when you get older and your dependents won't depend upon your income quite as much.
While laddering, you'll also receive protection in case you become disabled and can't pay your mortgage. That's where the premium waiver and disability rider come in.
"It's a simple concept. Only pay for the life insurance you need," Holloway says.
David Reischer, attorney and chief executive officer of New York City-based LegalAdvice.com, said that before taking out any mortgage protection policy, homeowners should speak with an attorney. Why? These policies can vary significantly from company to company.
"Mortgage protection insurance is only as good as the terms of the policy," Reischer says. "It is important to have the policy reviewed and explained by a qualified attorney who can explain the conditions by which the policy will go into effect. Nobody wants to waste their money on premiums for an insurance policy that does not pay out when the beneficiary expects a payout."