What is mortgage protection insurance? So many financial products contain the words "mortgage" and "insurance" in their names that it's hard to tell them apart. For example, there's private mortgage insurance and the Federal Housing Administration's mortgage insurance premium. Even though you may have to pay for them, both those only protect the lender in the event of your defaulting. The only benefit they give you is that they allow you to borrow when your mortgage application would otherwise be declined, often because your down payment is lower than normally required.
What Mortgage Protection Insurance Is
Mortgage protection insurance (sometimes called mortgage payment protection insurance) is different, and provides you with potentially valuable benefits. It can cover your monthly payments when you lose your job or while you're unable to work through illness or disability. And it can zero your mortgage balance on your death, leaving those you love (or, at least, the beneficiaries of your estate) with a home unencumbered by that debt.
If there's one thing that, for many, slightly takes the shine off buying a new home, it's the small but nagging fear of being engulfed by just such a personal disaster. So it's no surprise that home owners are often bombarded with mortgage protection insurance offers soon after purchasing or refinancing. And, for some, the premiums required for peace of mind are a price well worth paying.
However, as with all non-mandatory insurance, it's important to balance the cost of cover with the risks protected. It's also important to recognize that the insurer is making precisely the same calculation: it's going to set premiums that reflect the chances of you personally making a claim. So if you're older, in poor health, or work in a job that carries a high risk of being laid off or of injury, illness or disability, you may find it prohibitively expensive to obtain the coverage you want. If you're young, fit and in a safe job, you may be able to afford the policy's costs, but you may calculate that you don't need the protections it provides.
You should also recognize the nature of the benefits provided, in particular, that they're tied to your mortgage. That means that the value of the coverage in the event of your death is going to reduce as you pay down your mortgage. Suppose you're age 40 now and have just bought a home with a $200,000, 30-year fixed-rate mortgage. The chances of your dying now and your estate getting the full $200,000 are relatively small. The chances of your dying toward the end of the loan term, when you're approaching 70 years of age, are much greater. But by then you'll have paid down nearly all you owe, so your estate may benefit by only a few thousand dollars.
Similarly, the prospect of finding your monthly payments during a spell of unemployment or sickness now may fill you with horror. But by the time you're most likely to make a claim, after 20 or 30 years of saving, and rising salaries and home prices, those payments may look a lot less scary.
Know Your Coverage
Of course, all insurance involves pooling risk, and only works because most policyholders don't make claims. Mortgage protection insurance is no different in that respect.
It's also the same in that you need to understand the coverage provided. In particular, ask yourself:
- Are there excesses/deductibles that mean my coverage kicks in only after my losses reach a certain level?
- Are there caps on the total I can claim for certain risks?
- Are my monthly payments going to be paid in full by the insurer if I'm sick, disabled or unemployed, or will I still have to find some money?
- Are there exclusions that might limit my coverage if my circumstances alter? For example, what happens if I change careers and begin to work in a higher-risk category of job?
Even if you're happy the coverage matches your need, you still need to make sure you're getting the best possible deal. You shopped around for your home. You probably shopped around for your mortgage (see How Much Shopping Around for a Mortgage Can Save You), now you need to shop around for your mortgage protection insurance.
Many experts suggest doing this within the context of a wider financial review, which might throw up alternatives to this type of insurance. Again there are questions you could ask yourself:
- Might a life policy, which maintains its value throughout its term, be a better bet for me?
- Are there better-value forms of insurance that would cover me more cheaply for unemployment, sickness and disability?
- Could building up a worthwhile emergency fund, partly using the money that would otherwise go into premiums, provide as good and more flexible coverage for personal disasters?
- Might I eventually (when my risk is highest) be able to use the equity I build in my home to see me through many of these sorts of difficult times – perhaps using a home equity line of credit or reverse mortgage?
After answering those, you could well still reach the conclusion that mortgage protection insurance is your best bet. You should then compare different policies from different insurers to make sure you're achieving the optimum premium/coverage ratio for your needs. This will take some effort, but you're making a long-term – maybe three-decade long – commitment when you sign up for one of these policies. And, over such periods, even small monthly savings really do add up.