When you take out a mortgage to buy a new property, your lender may require you to purchase a mortgage loan insurance. At the same time, they may offer you life insurance for your mortgage. Should you accept it?
Your home is likely the most significant asset you’ll ever acquire, so it’s natural to want to protect it and ensure your family is taken care of if something happens to you. After all, your mortgage is a significant debt that you wouldn’t want to pass on to your loved one.
But what is the difference between these two types of insurance, and which one is the best for your situation?
Mortgage life insurance vs. life insurance: which one should you choose?
While it can be difficult to differentiate between the two, there are key distinctions between mortgage life insurance and life insurance, particularly when it comes to the beneficiaries who will be covered in the event of your death.
Mortgage life insurance: what is it?
Mortgage life insurance if offered by your bank and is directly linked to the purchase of your property. It is tied to your mortgage and your lender.
The main advantage of mortgage life insurance is that it is typically quicker and easier to obtain than traditional life insurance. There is no medical examination required to assess eligibility. After answering a few questions, you will be assured that the balance of your mortgage will be paid off in the event of your debt.
However, while it is easy to obtain, mortgage life insurance offers less flexibility than individual life insurance, as it is primarily designed to meet the needs of the financial institution. It’s important to note that the premium for life insurance remains fixed, even though your mortgage balance decreases over time and the coverage amount reduce accordingly.
Mortgage life insurance does not cover income loss in the event of death. While it ensures your heirs inherit a debt-free home, it only reimburses your lender. Therefore, while it is quick and convenient, mortgage life insurance if often less advantageous and flexible than individual life insurance.
Individual life insurance: what is it for?
Unlike mortgage life insurance, individual life insurance offers more flexibility, allowing you to tailor your coverage to meet your specific needs. You can choose the amount of coverage, which can include paying off your debts and providing income for your family in the event of your death. Additionally, you have the ability to designate your beneficiaries.
Term life insurance is a particularly beneficial option for protecting the financial security of your loved ones. It provides temporary coverage (10, 15, 20 years), which can align with the duration of your mortgage if desired.
If you die during the coverage period, your beneficiaries will receive a tax-free death benefit. They can then use the funds to pay off your mortgage or for any other purpose. However, since they have the freedom to use the money as they see fit, there is no guarantee that the funds will be used specifically for the mortgage.
It’s important to note that obtaining individual life insurance can be more complex than mortgage life insurance. Depending on your age, health status, and the coverage you choose, you may need to answer a more detailed questionnaire than the one provided by your lender, and a health examination may also be necessary before the insurer approves your application.
What amount of insurance coverage should you choose?
The amount of insurance coverage you choose will depend on whether you opt for a mortgage life insurance or an individual life insurance. With mortgage life insurance from your financial institution, your coverage is tied to your loan balance. For example, if your mortgage is $275,000, your insurance coverage will initially be $275,000.
Over time, as you repay your mortgage, the balance decreases, and so does the coverage. When your loan is fully paid off, the insurance ends, meaning there is no remaining benefit for your loved ones.
In contrast, individual life insurance gives you more flexibility in determining your coverage amount. You can choose coverage that matches your mortgage amount or adjust it is to meet other needs, such as providing additional income or leaving a larger inheritance.
One key advantage of individual life insurance is that the coverage amount does not decrease as your mortgage balance does. If you choose coverage equal to your original mortgage amount of $275,000, and at the time of your death your mortgage balance is $180,000, your beneficiaries will not only be able to pay off your mortgage but also receive the remaining $95,000 as an inheritance.
Who are the beneficiaries in the event of death?
With mortgage life insurance, the financial institution is the sole beneficiary. In the event of your death, the insurance will pay the balance of your mortgage directly to your bank. This means there is no additional money available to cover other expenses, and your loved ones do not receive a death benefit.
On the other hand, with individual life insurance, you have the option to choose your beneficiaries. This allows you to protect your family, who will have more flexibility in using the insurance payout. The funds can be used for various purposes, such as paying off your mortgage balance, covering other debts, funeral expenses, or any other financial need.
What happens if you transfer your mortgage?
The two types of insurance also differ when it comes to transferring your mortgage.
Mortgage life insurance typically does not transfer if you decide to change your mortgage provider. In this case, you would likely need to take out a new insurance policy with your new lender. This can be disadvantageous if you have ages or your health has changes, as you may face higher premiums of difficulty qualifying for coverage.
In contrast, with individual life insurance, you can keep the same policy regardless of which lender you choose. There’s no need to renew your insurance application or provide new proof of eligibility, meaning the coverage stays with you even if you switch lenders.
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