While life insurance offers broad financial protection, including a versatile ‘death benefit’ that can be used for various purposes, mortgage insurance concentrates on repaying outstanding mortgage balances upon the event of the policyholder’s death, primarily benefiting the mortgage loan lender. Life insurance aims to provide long-term financial security, while mortgage insurance is more geared towards serving the lender’s financial interests.
To help you to understand the differences between the two, in this article, we’ll be exploring:
- The main differences between life insurance and mortgage insurance
- How to know which cover is right for you
- The key benefits and detractors of life and mortgage insurance
Let’s get into it.
Defining Life Insurance
Life insurance is a financial tool which is designed to offer financial peace of mind to policyholders and their families. Its primary purpose is to provide a financial cushion to beneficiaries – those named in the policy paperwork – or dependents – those relying on the policyholder’s income to maintain their living standards – in the event of the insured individual’s death.
This ‘safety net’ comes in the form of a predetermined sum of money, also known as the death benefit, which is paid out to the policy’s designated beneficiaries or dependents upon the policyholder’s passing. The coverage amount, which can be customised based on the individual’s preferences, plays a critical role in determining the level of protection the policyholder’s family will receive at termination.
It’s typical that the premium structure of life insurance involves regular payments made by the policyholder to the insurance company to keep the policy in force, usually in the form of monthly payments. The structure of these payments can vary depending on the type of policy chosen, the coverage amount and the policyholder’s specific risk profile as calculated by the insurer.
To clarify the terms between life and mortgage insurance, let’s now take a look at the latter to distinguish the key differences.
Defining Mortgage Insurance
Mortgage insurance is a specialised form of insurance which is designed to protect lenders against the risk of the borrower defaulting on a home loan – this is to say that the lender is covered in the event of the borrower’s passing, ensuring the loan amount on the mortgage is paid. The primary function of mortgage insurance is to safeguard the lender in case the borrower is unable to make their mortgage payments – either due to critical illness, being unable to work, or even in the event of passing.
While this insurance is available to everyone, it typically becomes a requirement if the borrower makes a down payment deposit that is less than 20% of the property’s purchase price. Mortgage insurance encourages lenders to extend loans to borrowers who might not otherwise qualify for mortgage financing by reducing the lender’s risk with this financial safety net.
Mortgage insurance is kept running as a result of a premium payment structure, which is typically included in the borrower’s monthly mortgage payments. This premium – or monthly fee – is calculated based on the loan-to-value ratio, with the amount of the loan compared to the property’s value, and is often paid off over the lifespan of the loan, or until a certain loan-to-value threshold is met.
This is to say that mortgage insurance is geared towards benefitting the lender in times of trouble, rather than the policyholder when directly compared to life insurance. But, mortgage insurance does ensure continuity of living conditions for dependents of the policyholder, ensuring that they don’t have to sell their house to cover end-of-life costs, for example.
Coverage Purposes and Differences Between Life Insurance and Mortgage Insurance
Life insurance serves as a versatile financial tool, providing coverage for a range of needs beyond mortgage protection.
In the event of the policyholder’s death, life insurance can provide a lump-sum payment that can be utilised to cover various financial obligations, including household expenses, debts, education costs and other financial costs such as funeral fees or end-of-life arrangements. This flexibility allows individuals to tailor their life insurance policies to their specific circumstances, ensuring comprehensive protection is provided for their loved ones.
In contrast, mortgage insurance specifically covers the outstanding balance of a home loan mortgage in the event that the borrower is unable to continue making mortgage payments as usual. This type of insurance safeguards the lender’s investment, ensuring that the loan will be repaid even if the borrower defaults (e.g. you have stopped making payments as arranged in your policy).
It’s important to note the distinction that mortgage insurance is designed to protect the lender rather than the borrower’s family or beneficiaries, focusing solely on the outstanding mortgage balance, whereas traditional life insurance is in place to protect the beneficiaries in the event of the policyholder’s death. There is of course continuity of your family home to take into consideration, as it won’t be claimed or taken away to cover missing payments, but the main distinction is that you – as a beneficiary – won’t receive any additional payments like a death benefit as seen in life insurance.
Premium Structure of Life Insurance and Mortgage Insurance
Life insurance typically features a premium structure that remains consistent throughout the policy term, ensuring the predictability of regular payments for the policyholder, usually one payment per month. This fixed premium approach offers peace of mind and allows for easier financial planning, as the policyholder can anticipate the same premium payment for the duration of the policy.
On the other hand, mortgage insurance premiums often differ from life insurance premiums in their front-loaded structure – which is to say that the premiums you pay in the beginning will be paying off the interest on your loan, rather than the actual loan balance. These premiums are typically calculated based on the initial mortgage balance, and then gradually decrease in amount as the mortgage – and subsequent insurance – is paid off.
The initial premiums in mortgage insurance are higher to cover the lender’s risk during the earlier stages of the mortgage, and they gradually taper off as the borrower reduces the outstanding balance and proves their financial stability by being a regular payment provider.
Beneficiaries and Payouts in Life Insurance
The beneficiaries in life insurance policies play a crucial role in receiving the tax-free death benefit paid out by the insurer upon the policyholder’s passing. This death benefit serves as a financial lifeline for the deceased’s loved ones, ensuring that they are not burdened with significant financial obligations during an already challenging time.
The tax-free nature of this payout offers a considerable advantage, allowing beneficiaries to receive the full benefit without deductions.
The payout can serve to replace lost income, ensuring that the family’s financial stability remains intact, and can be used to cover outstanding debts, such as mortgages or loans, preventing the family from facing financial strain. The death benefit can also be used to cover funeral and end-of-life expenses, alleviating the financial burden associated with these significant, and sometimes unexpected, costs.
Beneficiaries and Payouts in Mortgage Insurance
In the case of mortgage insurance, the payout is typically directed to the lender rather than to specific beneficiaries. This mechanism aims to protect the lender in the event of the borrower’s death, ensuring that the outstanding mortgage balance is covered and no money is lost on their end.
By paying out to the lender, mortgage insurance helps prevent the possibility of the borrower’s family being burdened with the mortgage debt, therefore allowing them to retain ownership of the property and preventing further untimely loss.
From the borrower’s perspective, mortgage insurance can be beneficial as it enables them to secure a home without having to provide a substantial down payment or deposit which is often seen as a barrier to entry when purchasing a house in today’s economic climate. Additionally, it ensures that their dependents are not left with an outstanding mortgage balance, which can help to provide financial relief especially if they are not in a position to cover the finances themselves.
Flexibility and Portability of Life Insurance
Life insurance policies offer a high degree of flexibility and portability, enabling policyholders to adjust their coverage to meet their changing financial needs. This adaptability ensures that the chosen policy remains relevant as life circumstances evolve, allowing for alterations such as increasing or decreasing coverage amounts, adjusting beneficiaries, or incorporating additional add-ons to enhance protection in certain areas, such as medical.
Unlike mortgage insurance which is tied to one sole purpose, life insurance can serve a broader range of purposes, providing comprehensive financial security for loved ones way beyond the scope of mortgage protection. It serves as a safety net, addressing various needs such as income replacement, debt repayment, educational fees and estate planning.
One of the significant advantages of life insurance is its capacity to offer long-term financial security that extends well beyond mortgage protection. Some life insurance policies have the added ability to accumulate cash value, as well as provide a tax-free death benefit.
This can help policyholders to build a financial legacy to support dependents, supplement their retirement income and address potential estate taxes. The flexibility of life insurance in its ability to cater for diverse financial scenarios makes it a powerful tool in ensuring the continued well-being of beneficiaries, while preserving the financial stability of the insured’s family in the long run.
Applicability and Termination of Mortgage Insurance
Mortgage insurance is typically required for borrowers who provide a down payment deposit of less than 20% of the property’s value. For these individuals, mortgage insurance serves as a risk-mitigation tool for lenders, safeguarding them – the lender – against potential financial losses in case the borrower’s payments default.
This insurance type enables borrowers to secure a mortgage with a lower initial down payment, making homeownership more accessible to more of the population. However, this insurance requirement adds an extra cost to the monthly mortgage payment, affecting the overall affordability of the home in the long run.
Mortgage insurance can often be terminated under certain conditions, such as reaching a specified level of equity in the property. This can occur when the outstanding mortgage balance decreases to a point where the loan-to-value ratio falls below 80%, primarily through the reduction of the original balance.
Borrowers should monitor their mortgage statements regularly to determine when they have met the requirements for terminating mortgage insurance. Additionally, some loans may have specific guidelines established by the lender or mortgage servicer that must be followed for mortgage insurance cancellation – there is the potential that you can overpay these types of premiums, so it’s best to keep track of the financials when opening a policy like this.
It’s also likely that the first few payments are tackling the interest on the loan, rather than the loan itself, which can mean you end up paying more over time than you would with a standard fixed-fee loan. While the mortgage insurance offers a gateway to housebuying, there are drawbacks, which we will cover in the next section.
Advantages and Drawbacks of Life Insurance
Life insurance provides versatile financial protection that extends beyond mortgage coverage. It offers a safety net for beneficiaries, providing financial stability and security in the event of the policyholder’s death.
Beyond mortgage protection, life insurance serves as a tool to replace lost income, cover living expenses and fund future financial goals, such as education for dependents or retirement savings. Its flexible nature allows policyholders to adapt their coverage to evolving circumstances, ensuring that their loved ones are adequately protected in the event of their passing.
Despite its comprehensive coverage, life insurance can come at a higher cost compared to mortgage insurance, especially for policies with sizable coverage amounts or extended durations. The premium payments for life insurance policies may be more substantial due to the broader financial protection they provide, but their payouts are typically tax-free which is a big advantage.
Advantages and Drawbacks of Mortgage Insurance
Mortgage insurance plays a vital role in facilitating homeownership, particularly for borrowers who are unable to make a 20% down payment deposit on their home. Reducing the lender’s risk enables individuals to secure loans with more favourable terms and interest rates, making homeownership more accessible.
But, despite its role in making homeownership more attainable, mortgage insurance is primarily focused on covering the outstanding balance of the home loan, with limited flexibility beyond mortgage coverage. This is to say that it does not provide the comprehensive financial protection and versatility that life insurance offers.
Additionally, once the borrower’s equity reaches 20%, mortgage insurance may no longer be necessary, limiting its utility in the long run – there is also no cash payout like the death benefit often seen in traditional life insurance policies, meaning an additional insurance type may be necessary if funding may be an issue once the policyholder has passed.
Mortgage insurance is geared towards helping the lender, rather than the borrower, which is the opposite of life insurance policies.
Life insurance and mortgage insurance serve two distinct purposes, with life insurance providing comprehensive financial protection to beneficiaries in the event of the policyholder’s death, while mortgage insurance is primarily intended to safeguard the lender by covering the outstanding balance of a home loan.
Both insurance types involve the payment of premiums, but they differ in terms of their payment structures, with life insurance often featuring consistent, fixed fee premiums throughout the policy term, whereas mortgage insurance premiums may be front-loaded and linked to the outstanding mortgage balance and subsequent interest, with a commonly decreasing premium amount as the policy wears on.
It’s essential for individuals to carefully evaluate their financial situation and consider the long-term benefits versus the costs when deciding whether to opt for life insurance instead of mortgage insurance. This can be properly assessed with the help of a financial advisor, who can talk you through everything you need to know to find out what’s best for your individual situation.