Mortgage Life Insurance Explained

Mortgage life insurance – also known as decreasing term insurance – is a way to provide financial protection to your loved ones in the event of your death.

The policy will pay a lump sum to your dependents to cover the mortgage you leave behind should the worst happen during the policy term.

Why is mortgage life insurance useful?

If you are buying your home with a mortgage and have loved ones who depend on your income, you will want to consider mortgage life insurance. If you die without it, your dependants may struggle to afford the mortgage, which might mean they have to move out of the property, perhaps into alternative accommodation.

But if the mortgage can be cleared using the proceeds of a life insurance policy, this disruption can be avoided at an already difficult time.

If you are married or have a partner, it can be worth getting mortgage life insurance for each of you, even if one of you does not earn an income. This would ease the financial stresses that would inevitably follow the death of either of you.

For example, if the partner who stayed at home were to die, clearing the mortgage with the life insurance payout would free-up earnings to pay for items such as childcare.

The cheapest way to get cover for two people is with a joint policy, but note that such policies usually only pay out once, so the surviving partner would have no insurance if a claim were made.

For this reason, and if funds allow, it can make sense to take out separate policies for each person.

How does it work? 

This type of insurance is called ‘decreasing term’ because your ‘sum insured’ – the amount you would receive if a claim were made – reduces year-on-year in line with what’s outstanding on your mortgage.

Note that this situation applies to ‘capital and interest’ repayment mortgages, where you pay off the interest and part of what you owe each month.

If you have an interest-only mortgage, the amount you owe doesn’t decrease over time and is paid off in one go at the end of the loan period, so decreasing mortgage life insurance would not be worthwhile. Instead, you would need level term insurance, where the potential pay-out is fixed.

Interest-only mortgages are rare these days. If you have a mortgage, it is likely to be the repayment variety.

It’s also worth remembering that mortgage life insurance will not provide money beyond the amount owed to your lender, so you should think about how you might want to cover other household bills and your dependent’s living costs.

Again, a level term insurance policy would be more suitable but would cost more because of the greater sum insured.

Should I buy from my mortgage lender?

While your mortgage lender may encourage you to take out a policy and may even stipulate that your having life insurance is a condition of its granting the mortgage, you don’t have to buy any policy they offer. 

It’s important to shop around to see who is offering the best deal in terms of the cover you require and the size of the premium.

How much cover do I need?

Cover is based on the size of your mortgage, how long it has to run, and the rate at which the amount you owe decreases over time. 

Note that, even though the amount of cover you have will decrease over time, the premium will be calculated in such a way that it remains the same from start to finish.

What are the alternatives?

The life insurance you choose should be specific to your needs. Mortgage life insurance may not suit you, but another type of policy could:

Level term insurance Level term insurance pays out a set lump sum to your dependents if you die during the term. 

Increasing term insurance With an increasing term policy your cover will rise year-on-year in line with, for example, increasing inflation. 

Death in service cover This type of life insurance is provided by your employer as a work benefit. It is usually calculated as four times your annual salary, although it is worth checking to see what cover is provided. The amount you have may affect how much you buy separately.

Should I add critical illness cover?

Critical illness cover provides an additional level of security should you fall ill and not be able to work during the insurance term. 

Make sure you write your policy ‘in trust’

When you buy life insurance, ask your insurance provider to write the policy ‘in trust’. Doing so means any pay-out from the policy is not included in your estate but will instead be paid straight to the beneficiaries of the policy, as chosen by you.

Writing the policy is a routine process simply requiring a signature on your part.