How mortgage life insurance works

Mortgage life insurance is a common type of insurance to protect your property and your dependents should the worst happen to you. Your home is one of the biggest investments but also the largest source of personal debt. Therefore, protecting your loved ones and property is very important.

A sudden disability or a premature death can enormously stress your family as they will be looking for ways to pay off the mortgage. If something happens to you, mortgage payments may become unbearable and your family may face big financial hardships that may require them to sell the property. By purchasing a mortgage policy, your dependents actually buy a means to protect themselves in case of a sudden loss of income. Should you pass away before the mortgage is paid off, your mortgage life policy will provide your dependents with a fixed death benefit for immediate financial protection. In fact, your loved ones can use the lump sum to make their mortgage payments or pay off the loan.

Mortgage life insurance declines in value as the policyholder pays higher premiums to the insurance company. In other words, the more money you pay the less coverage you get as you grow older. On the other hand, in the event of your death or disability, your dependents do not have to worry about making their mortgage payments.

Here is how a mortgage policy works:
You can determine the level of coverage so that is in line with your outstanding mortgage and the number of years the policy will be in place. The first five years, the value of your coverage is fixed and equals the outstanding balance on your mortgage. The expiry date must be the same as the date that your final mortgage payment is due.

In year six, the insurer determines the annual rate at which your coverage will be decreasing to equal the outstanding balance on your mortgage. Even if you are behind in payments, the insurer will proceed to decreasing your insurance coverage. At the same time, your premium increases. For instance, if you bought a 30-year mortgage policy in your 25s with a monthly premium of 1,000 GBP, in your 40s with 15 years remaining amortization you can pay as high as 1,400 GBP.

The mortgage policy ceases as soon as your dependents collect the lump sum against your death or disability. If you survive the term and the lump sum has not become payable, the policy ceases and your dependents do not collect anything as the policy has no cash value to borrow against or withdraw.

There are two types of mortgage life insurance to consider:

  1. Decreasing term life insurance: the amount of coverage declines over the specified term of the policy in line with the outstanding balance on your mortgage, so you are only paying for the life coverage you need.
  2. Level term life insurance: the amount of coverage remains fixed over the specified term of the policy to align with the fixed level of outstanding mortgage. 

You can also purchase a mortgage policy on a single or joint life basis, with the lump sum being paid out on the first claim only. You may also add critical illness benefit for a higher premium to cover for cancer, heart attack or stroke. In this case, the lump sum is being paid out on death or the diagnosis of a particular critical illness, whichever occurs first.

In short, the underlying concept of mortgage policy is that if you pass away or become incapacitated, mortgage insurance will pay off the outstanding balance of your mortgage. However, given the paradox mechanics of the product you should be careful with the chosen level of coverage to avoid higher premiums. Also, keep in mind that the coverage provided by a mortgage policy typically ranges between 15 and 30 years. So, the sooner you start, the better.

Jacob Chapman has been working in the financial industry for years when in 2009 he decided to focus his experience on helping individuals better understand the plans and policies they are offered. You can read his articles on mortgage life insurance on and life assurance on .

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