Soon after you purchase a home using mortgage financing you will start to receive unsolicited letters in the mail from your financing company’s “partners”. Somewhere in that fine print of your mortgage paperwork you agreed to have your information shared with the company’s partners. One of the first partners you will hear from is a company offering mortgage life insurance. What exactly is mortgage life insurance? Should you buy it? Let’s take a look.
Mortgage life insurance is a financial product that insures your life for the value of your mortgage. If you die or become disabled while you hold a mortgage in your name, the insurance policy kicks in and pays off the balance of your mortgage. This frees your family from the burden of having to pay for the house after you die or become disabled. While protecting your family with life insurance is an important family decision, mortgage life insurance may not be the best decision.
Life insurance is important, but mortgage life insurance leaves a lot to be desired.
First, mortgage life insurance covers your mortgage balance. That protects your family from the payments, but it also protects the bank from default on the mortgage — similar to Private Mortgage Insurance (PMI). While your family does get a benefit, you are also paying to benefit the bank.
Secondly, with mortgage life insurance you pay a flat monthly cost for an always decreasing benefit. If you bought a house today with a $150,000 mortgage, paid for mortgage life insurance, and died the next day, your family would get the full $150,000 benefit. But as time goes on and you pay off your mortgage through monthly payments, the total benefit your family receives goes down. A $150,000 mortgage today becomes a $100,000 mortgage in the future which becomes a $50,000 mortgage further in the future. But as your mortgage balance — and thus life insurance benefit — goes down, the monthly cost stays the same.
Finally, there are simply better options when it comes to life insurance. A mortgage life insurance has a very specific benefit that decreases over time. There is a better way to cover your mortgage balance and more: a term life insurance policy.
A general rule of thumb in life insurance is that you need a policy that covers 10 times your current salary. The idea is to provide your family with enough income to adjust to you not being there over a long period of time rather than immediately. If you make $50,000 per year a good term life insurance policy would pay $500,000 or more to your family. That’s 10 years of your “income” that they can build into the budget.
With mortgage life insurance the only part of the budget that changes is the mortgage payment. All of the other costs of life — car payments, utilities, cell phones, groceries, and so on — still exist. While your mortgage is likely the largest piece of your monthly expenses, your family probably relies on more of your income than just the amount that pays for the mortgage each month.
Alternatively, a term life insurance payout could be used to pay off the mortgage — just like mortgage life insurance — while still providing additional money to cover other expenses for many years.