Everything You Need To Know About Mortgage Life Insurance

Your mortgage is likely to be the biggest financial commitment you ever make. But what would happen if you’re no longer here to make the payments? How would your partner or family cope if they suddenly had to pay the mortgage?

In our guide, we look at the types of life insurance that are available to protect your mortgage. Keep reading to find out more.

Life insurance provides a lump sum in the event of your death

According to research from Finder, just 50% of UK households with a mortgage have life insurance. This means that there are millions of people who would leave a mortgage debt if they were to die before their mortgage is repaid.

Luckily, dozens of companies offer easy-to-understand and affordable life insurance. Life insurance is designed to provide a lump sum in the event of your death within a specific term.

It ensures your partner or family have financial support if the worst should happen, and ideally allows them to repay any outstanding mortgage balance. Having enough life insurance in place to repay your mortgage will allow your dependents to remain in their home without having to worry about making the monthly repayments.

There are two main types of life insurance:

• Decreasing term assurance
• Level term assurance

We’ll look at these types of insurance next.

Ensure your outstanding repayment mortgage is repaid

Most new mortgages are taken out on a capital and interest (or ‘repayment’) basis. This means that your monthly repayment includes both interest on the loan and part of the original amount that you borrowed. Over the course of your mortgage term, the outstanding balance reduces until your loan is paid off at the end.

If you’re looking for a simple life insurance product designed to clear your outstanding repayment mortgage, then decreasing term assurance could be suitable. As its name suggests, it’s a type of life insurance where the sum assured (the amount of cover) reduces roughly in line with your repayment mortgage.

If you were to die towards the start of your mortgage, then the policy would pay out enough for you to clear the whole loan. If you die towards the end of the term, your payout will be lower – although designed to be enough to cover whatever mortgage balance is outstanding.

Level term assurance provides a fixed amount of cover

A level term assurance policy provides a fixed amount of cover for a fixed amount of time. For example, you may take out £100,000 of cover over a fixed period of 20 years. If you die within the term of your policy, it will pay out the fixed sum assured which always remains the same. Historically, this type of policy was used to cover an ‘interest-only’ mortgage where the loan balance did not reduce over the term.

However, you can choose a level term policy even if you have a repayment mortgage. Taking level term assurance means that as well as providing enough to repay the balance of your mortgage, there will be some cash left over which your dependents can use as they wish.

Consider single-life rather than joint-life cover

When you take out life insurance you can take it in your own name or in joint names. If you take out a joint policy, it will typically pay out on ‘first death’ and then the policy will end.

Your alternative is to take out individual policies. The advantages are:

• You will increase the amount of cover you have in place, as both policies will potentially pay out on death. For example, if the two parties die in an accident while covered by a joint-life policy, the policy would pay out just one lump sum. Under separate policies each would make a payout.
• You can retain your own life cover if you were to split up with your partner. You cannot generally remove a name from a joint-life policy and so couples often end up having to cancel cover if they separate. With separate policies you can retain your own cover and protect your dependents as you choose.

The main disadvantage of a joint-life policy is that it may cost more than two separate policies.

How much does life insurance cost?

There are several factors that determine how much you will pay for life insurance:

• The type of policy you take (level or decreasing term assurance)
• The amount of cover you want
• Your age and the term – you will typically pay more for life insurance if you’re older
• Whether you smoke – smokers pay more for life insurance
• Your own health
• Whether you take out a single or joint-life policy
• Your job – some more dangerous jobs will result in higher premiums

The cost of cover varies between insurers. You’re generally not obliged to take life insurance with your mortgage lender, and so you should always shop around to find the best-priced cover for your needs.

What if I am diagnosed with a serious illness?

Many life insurers will allow you to include ‘critical illness cover’ with your life insurance policy.

Critical illness cover provides a tax-free lump sum if you’re diagnosed with one of a range of serious medical conditions, such as cancer, a heart attack, or a stroke. It is designed to provide you with the peace of mind of a lump sum that you can use to:

• Repay your mortgage
• Pay for private medical treatment
• Replace your income if you are off work for an extended period

If you choose a life cover and critical illness policy any payout will be on ‘first event’. This means that if you are diagnosed with an illness covered under the policy, it will pay the sum assured and then your policy will end. You won’t get a second payout on death within the term.

Some policies also make smaller payouts for less serious conditions or if one of your children is diagnosed with an illness covered under the policy.