If you currently own a home or are planning to buy one soon, you probably know that you’ll likely need a mortgage to pay for it. What you might not know is that if you have a mortgage, there’s something else you’ll want to get too: life insurance.
Whether you’re applying for your first mortgage or looking to secure a new one, getting a mortgage is a big financial commitment. That’s why it’s smart to have a safety net in place to protect your family financially in case something unexpected happens. This is where life insurance comes in.
Not sure what life insurance has to do with getting a mortgage? In this article, we break down the basics of how life insurance and mortgages go hand in hand.
What is Life Insurance?
Life insurance has a reputation of seeming complicated and daunting. But in reality, it’s a financial product that’s pretty simple to understand.
When it comes down to it, life insurance is a financial safety net that protects your family (or anyone who’s dependent on you) iff you die and your income disappears. When you buy a life insurance policy, you pay an insurance company a monthly fee (called a “premium”) for coverage. If you die while the policy is active, your insurance company will give your beneficiary a payout equal to your coverage amount (known as a “death benefit”).
Your beneficiary will receive the death benefit as a tax-free lump sum payment. And they can use the funds in any way they’d like to. For example, they can use the death benefit to complete a home renovation, make car loan payments, or cover the cost of daily expenses.
What is a Mortgage?
A mortgage is a loan that you take out to buy or refinance a home without having to pay the entire cost up front. Most people who get mortgages do so because they can’t pay the full purchase price of a home out of their pocket. However, it also makes sense to get a mortgage if you’re buying a property as an investment and don’t want to lock up all of your money in it.
When you get a mortgage, a lender loans you money to pay for a percentage of the cost of a home. You agree to pay this amount back with interest over several years. Because the lender pays for a big chunk of your home up front, you don’t fully own your home until you pay off the entire mortgage.
As a mortgagor, you pay the lender back by making regular payments based on the mortgage amount (or “principal”) and the interest rate. Your home is the collateral for the loan. So if you stop making mortgage payments, your lender can take possession of your home.
Why Should You Buy Life Insurance When You Have a Mortgage?
Okay, so now you know what life insurance is and what a mortgage is. But you might be wondering what they have to do with one another. In other words, why does life insurance matter when you have a mortgage?
Remember that when you take out a mortgage, you agree to pay your lender back the amount you borrowed plus interest. This won’t be a problem as long as you’re alive to earn a living and make those regular mortgage payments. But if you die before your mortgage is paid off and your income disappears with you, you could leave your family in a bind.
Specifically, if you’re partially or fully responsible for making the mortgage payments, your family depends on your income to fulfill the terms of the mortgage. If you die and you’re no longer around to contribute financially, your family will have to figure out how to afford the mortgage payments without your income. And if they’re unable to make the payments, they’ll have to sell the home and move.
Losing a loved one is traumatic enough. So the last thing you want is for your family to have to cope with your loss and struggle financially to keep a roof over their heads.
The good news is that there’s a way to protect your family from mortgage debt: by buying life insurance. If you have a life insurance policy that accounts for the value of your mortgage, you can make sure that your family won’t be in a bind if you’re no longer around to contribute to mortgage payments. They can use the death benefit they receive to continue making mortgage payments until the mortgage is paid off. Or they can choose to pay off the mortgage in full so they can focus on other expenses going forward.
Having life insurance that covers your mortgage is also important if someone co-signed the mortgage with you. You might need a cosigner to get a mortgage if you don’t have the credit history, assets, or income to secure a mortgage on your own. When someone cosigns a mortgage, they agree to take on responsibility for the loan if you don’t make payments. So if you die before your mortgage is paid off, your co-signer could end up on the hook for the remaining payments.
Life insurance protects your co-signer by ensuring that there will be funds available to pay off your mortgage if you’re no longer around to pay it off yourself. This way, your lender won’t go after your co-signer to get their money back.
For most people, term life insurance provides the best financial protection for mortgages. That’s because when you buy term life insurance, you pay for coverage for a certain number of years (usually 10, 20, or 30). You can select your policy length based on the amount of time you think it’ll take to pay off your mortgage. This way, you’ll pay insurance premiums only during the years when you need the financial protection.
Because term life insurance gives you coverage for a fixed number of years, it tends to be highly affordable. Insurers know that most people will outlive their term policies and won’t end up filing claims. As a result, insurers can charge lower premiums for coverage, making term life insurance policies cheaper than most people think.
What About Mortgage Life Insurance?
Some mortgage lenders will encourage you to buy mortgage life insurance when you take out a mortgage. Mortgage life insurance in Canada is insurance that’s specific to your mortgage. It ensures that if you die, your insurer will pay the remaining balance on your mortgage to your lender. This way, your family won’t have to worry about making payments without your income or selling the home.
Keep in mind, though, that mortgage life insurance has a number of limitations:
- It’s typically more expensive. When you apply for mortgage life insurance, you usually don’t have to undergo extensive medical underwriting. To compensate, your insurer will assume that you’re a high-risk applicant and charge you more for coverage.
- The beneficiary is your lender. If your family files a mortgage life insurance claim, the payout will go to the institution that gave you your mortgage. Unlike with standard life insurance, your family won’t see any of the money.
- The money can be used only to pay off your mortgage. Mortgage life insurance is dedicated insurance for your mortgage. So even if your family no longer needs the money to pay back the mortgage, they won’t be able to use the funds for other expenses.
- The payout amount decreases over time. For many mortgage life insurance policies, your payout decreases as you pay off your mortgage (even though your premiums remain the same). So unlike with life insurance, your policy actually decreases in value over time.
- You can’t transfer your policy. If you decide to switch banks before you pay off your mortgage, you won’t be able to transfer your mortgage life insurance policy to the new bank. You’ll have to apply for a new policy and because you’ll be older at this point, you might have to pay higher premiums. With life insurance, in comparison, you can switch banks while retaining your original coverage.
Life Insurance Protects Against Mortgage Debt
Applying for a mortgage is a great way to buy or refinance a home without having to pay for it all up front. But because holding a mortgage is a big financial commitment, it’s important to protect your family from the unexpected. Specifically, once you have a mortgage, you’ll want to make sure that there’s a financial safety net in place if you die and you’re no longer around to contribute to mortgage payments.
Both standard life insurance and mortgage life insurance can protect your family against mortgage debt. However, mortgage life insurance tends to be more expensive and restrictive. So if you’re looking for coverage that’s affordable, comprehensive, and flexible, standard life insurance (and, in particular, term life insurance) is your best bet.