Mortgage protection insurance

Over the years, many prospective clients have inquired about mortgage protection insurance. Specifically, they want to know if decreasing term insurance would be the best product for them.

In short, the answer is "no." I've never found a decreasing term product to be the most appropriate form of mortgage protection insurance. Instead, I've consistently found level term insurance to be the best choice.

To understand why this is so, the client needs to first understand the nature of mortgage protection insurance.

What is mortgage protection insurance?

Mortgage protection insurance is required by a bank or other lender on the life of the new mortgage holder.

Plainly put, the bank wants to make sure that - if this person unfortunately passes away before the mortgage is paid off - the bank can still collect the balance due.

This is a concern held by virtually every lender when a significant sum is at stake - not just mortgages. For example, life insurance is often required when a bank extends a loan to a business owner.

In the case of mortgage protection, banks will often make an agreement with an insurance company to offer decreasing term insurance.

What is decreasing term insurance?

BENEFIT. Decreasing term insurance is a mortgage protection product whose face amount (the benefit) mirrors the outstanding balance of the mortgage. Each year, the insurance benefit would decrease as the mortgage balance also decreases.

For example, let's say the beginning insurance benefit is $250,000 in year 1. To match the decreasing mortgage balance, the benefit might be decreased to $220,000 in year 5.

PREMIUM. The insurance premium stays constant. It's calculated to support a larger death benefit in the early years and a smaller death benefit in the later years.

BENEFICIARY. Typically, the bank is named as the beneficiary so that the outstanding mortgage balance can be paid off automatically.

Why is level term insurance a better choice?

When evaluating the different forms of mortgage protection insurance, two issues must be addressed.

ECONOMICS. The first issue is a question of simple economics. For example, would a decreasing term insurance product for thirty years be cheaper than a level term insurance product with the same premium guarantee period?

The fact of the matter is I've always found level term insurance to be less expensive. While many carriers produce level term insurance products, only a few produce decreasing term products. Therefore, I've found more competitive pricing among the larger pool of level term carriers.

In addition, companies now are producing level term products with a return-of-premium rider. This means that the policy holder will get a full refund of all premium paid if a claim is not made during the guarantee period. This option is not available with the decreasing term product, and makes level term even more attractive from a cost/benefit standpoint.

OWNERSHIP. The second issue is one of ownership - who decides how the benefit is spent.

Decreasing term insurance policies are typically held by the bank, and the survivor of the mortgage payor has zero control over the benefit.

What does this mean for the survivors?

Suppose the mortgage owner is survived by a wife, or a husband, or adult children - and they've determined the best financial decision is NOT to immediately pay off the mortgage. If the bank owns the policy, then the family unfortunately has no say and must simply accept the bank's decision. Of course, the bank can be expected to act in its own financial interest, not the best interest of the surviving family.

On the other hand, level term insurance products typically allow private ownership and control over the policy and the benefit. The beneficiary will have full control over the proceeds and can do whatever is in their own self-interest at the time.

Mortgage Protection Insurance, in Summary

Your best choice of mortgage protection insurance depends on two factors. First, which product is more economical? Second, which product provides flexibility of ownership?

In my professional experience, I always recommend my clients take a good look at level term as the preferred type of mortgage protection insurance.

Best wishes for health and success,

Steve Kobrin