Purchasing a home is likely one of the biggest financial decisions many Americans are going to make in their lifetimes – and for investments of this magnitude, it pays to be protected. There are several ways to go about this task. Getting home and contents insurance, for example, gives homeowners protection against worst-case scenarios that may happen to their properties.
Another type of coverage, called mortgage protection insurance (MPI), helps homeowners pay out the remainder of their home loans should circumstances render them unable to make monthly repayments. But while the additional protection that MPI provides may seem great to have at first glance, many experts say this kind of coverage is not suited to everyone. Here’s what US homeowners need to know about mortgage protection insurance.
How does mortgage protection insurance work?
Mortgage protection insurance, also referred to as mortgage life insurance and mortgage protection life insurance, is a form of life or disability insurance that pays off the outstanding balance of a home loan should the mortgage holder die or suffer a serious disability that prevents them from earning an income.
MPI policies generally cover the principal and interest portion of a mortgage. Different fees that homeowners incur such as HOA dues, property taxes, and home and contents insurance are often excluded, although policyholders may be able to purchase a rider to cover these expenses.
Mortgage protection insurance is sold by insurance agencies affiliated with mortgage lenders and by independent insurance companies that obtain information from public records. This is the reason why homeowners receive many offers after buying a property. MPI can often be purchased within 24 months of closing a loan, but some providers allow an extended period of up five years. Policies last for the same number of years as the term of the mortgage.
The terms and conditions for each mortgage protection policy vary, but generally, lenders would receive the payout equivalent to the amount the policyholder still owes should they die or become incapacitated during the policy term.
Mortgage protection insurance, however, is not a requirement when taking out a home loan, unlike private mortgage insurance (PMI), which is mandatory for borrowers whose down payment is less than 20% of the property’s value.
What are the benefits of mortgage protection insurance?
Some experts say that getting MPI can provide another layer of protection for those who need it. Some benefits of taking out this type of coverage include:
1. Guaranteed acceptance
One of the advantages of buying mortgage protection insurance is convenience, according to Brittney Burgett, marketing and communications director at life insurance specialist Haven Life.
“Anyone can buy a policy and typically no medical exam is required in the underwriting process,” she wrote in a blog on the company’s website. “This is especially helpful for someone with a pre-existing condition or an illness that either disqualifies them from other types of life insurance or pushes their life insurance rates up to an unaffordable level.”
But while passing up the underwriting process could push up the cost of coverage, the increase could be worth it in some cases, noted Nupur Gambhir and Rebecca Shoenthal, editors and life insurance experts at insurance marketplace Policygenius.
“Since life insurance rates are largely determined by the health of the applicant, skipping underwriting could result in higher insurance premiums, but it can be worthwhile if poor health would raise the premiums of a standard term life insurance policy even more,” they said.
2. Provides certainty
Another benefit of MPI is that takes the guesswork out of paying off a mortgage, Gambhir and Shoenthal added.
“Receiving a lump sum of money from a traditional term policy can be overwhelming. MPI is matched up to the mortgage balance and the money will go only toward that. Your family will never have to worry about having a place to live,” the pair explained.
3. Good supplement to life insurance coverage
Mortgage protection insurance can also be a good supplement to life insurance coverage, according to Andrew Marder, insurance and data analysis specialist at personal finance firm NerdWallet.
“If your mortgage is paid off with money from a mortgage life policy, then your family could use all the benefits from your term or whole life insurance policy for bills and other expenses,” he wrote in an article published on the company’s website.
What are the drawbacks of mortgage protection insurance?
Industry experts, however, also cited several reasons for opting out of this type of coverage, adding that taking out term life insurance is a better alternative. These reasons include:
1. Lack of flexibility
Mortgage life insurance policies do not provide the same flexibility that term life insurance coverage offers, the experts noted.
“Being able to cover mortgage payments is great, but you’re doing so at the expense of your family’s other debts and bills,” wrote Gambhir and Shoenthal.
“While the death benefit can remove the financial stress of paying a mortgage, your family could still be left with bills and other debt they can’t afford,” Marder added. “With a regular life insurance policy, your family can use the payout for the most pressing bills, whether that's mortgage payments, other loans or college tuition.”
2. Decreasing payout
As homeowners pay off their mortgage balance, a mortgage protection insurance’s payout declines, and with premiums staying the same, this means the policyholder may end up paying more for less coverage, according to Burgett.
“If you’re wondering whether you still have to pay the same premium every month for a smaller face value, yes, you do if it has level premiums,” she wrote. “That means the amount you pay every month does not change even if the value of the policy goes down.”
3. Higher premiums
Another disadvantage of taking out an MPI policy are the expensive premiums, which Burgett explained is the result of waiving medical examinations and skipping the underwriting process.
“Typically, the less an insurance company knows about you, the more risk they are taking on in insuring your life,” she wrote. “Because of this added risk, mortgage life insurance is usually going to be more expensive than a medically underwritten term life insurance policy.”
“A term life insurance policy can provide more bang for your buck than a mortgage life insurance policy,” Marder added. “A term policy allows you to choose your coverage amount and policy length. If you want to line up those options with your mortgage you can, but you’re not forced to.”