You’ve found the right house. Hopefully you’ve worked with a mortgage broker and found the right mortgage. I want to discuss the protection side of all this. When we get our mortgages, the mortgage lender is going to suggest that you get some sort of coverage to make sure that, in the event of an emergency, the lender is still guaranteed to get their money. In fact, it’s mandated by law that they offer it to you and if you decline, you sign a disclosure form making clear that you understand the risk.
This is something people need to sit down and discuss with the people involved, whether it be a husband, wife or maybe even a business partner and figure out what’s important to them. They need to consider things like can the survivor maintain their lifestyle if they have to pay for the mortgage on their own. Maybe they decide that selling and simplifying their life is what they want to do. Maybe the survivor makes enough money to carry on with all this, regardless.
What Are Your Options?
I want to cover two of the more popular options available to consumers and both come in the form of life insurance. On one side we have mortgage life insurance and on the other we have term life insurance. On the surface, both products are very similar and in a pinch any one would do. Both offer protection and both are life products. I want to go over the differences between the two to give a clearer idea of which would be best for you.
Who Is The Coverage Really Covering?
First up is the beneficiary. With mortgage life insurance, the coverage is tied with the lender. So when you die, the money goes to the bank you got the mortgage from. Which makes sense. After all, they gave you the money to buy the house, so it makes sense they would want to make sure they get the money they’re owed if someone can’t pay for the remaining amount after a death.
On the other hand however, with term, instead of the bank being the beneficiary, you choose who it is. Most like the flexibility of having their survivor decide how to use the money. So if Frank dies, his wife Christine would then get this money and decides that there are more important things to use the money for other than paying off the mortgage. Maybe she has a high interest credit card she wants to pay off and pays off whatever mortgage she can with the remainder, working off the rest of the mortgage in time. She has that choice. So with mortgage insurance, the bank is the beneficiary. With term, you choose the beneficiary.
Are You Getting What You Paid For?
Next, with mortgage insurance, the coverage is what we call a declining death benefit. What this means is that the coverage will match exactly what the mortgage is worth. So as you pay down your mortgage, your benefits decline to match the value of that. Which makes sense. It’s designed to cover the mortgage, so it may as well cover exactly that.
Term on the other hand has a level death benefit. What this means is, as you pay down the mortgage, if you signed up for $500,000 you get… $500,000. Imagine you have $10 left on the mortgage to pay off and you die. Your survivor pays the mortgage and has $499,990 left for other things that are important to them. So mortgage insurance has a declining death benefit, term insurance offers a level death benefit.
Securing That You’re Actually Secure
Next, and probably the biggest issue and the one I really hope you take away from all this is the underwriting. Underwriting is the process that an insurance company goes through to determine someone’s eligibility for coverage. With a term policy, the underwriting involves 38 questions pertaining to your past and current health asked by a nurse, as well as a blood and urine test. So they really want to know how big of a risk you are. So let’s say you smoke, do heroin, you’re 75, suffer from multiple life threatening diseases, work as a deep sea welder, and sky dive on the weekends.
You’re at much higher risk of dying than someone who’s 30, a non-smoker, healthy in every way, and works an office job. So the underwriter will look much more favorably on the latter in terms of coverage and premiums, while the former probably wouldn’t even be eligible for coverage. But at the very least they know. So when they buy a house, they understand that all that risk is on their shoulders.
Conversely, with mortgage insurance, it’s almost the exact opposite. You’re underwritten at the time of claim. This means, that when applying for the coverage they’ll ask you four questions about your health. When you die, that’s when they decide to underwrite you. So all this time, you’re paying for insurance that’s going to help your survivors live after you die. You die, get underwritten and they find that you might not actually be eligible for coverage.
So how difficult is it to actually get a payout for mortgage insurance? To date in Canada, about 5% of claims get paid out. So 95% of the survivors who were hoping for this money are now thinking to themselves, how am I going to pay for this? How am I going to make ends meet?
So What Does All This Mean For You?
Just to recap, with mortgage insurance, you get underwritten at time of claim, the benefits are on a declining scale, and the beneficiary is the bank. Get a term insurance policy and you get underwritten at time of application, benefits are on a level scale, and you choose the beneficiary…
So what’s the catch, right? Well there is a cost issue to consider. Term policy is advantageous in almost every possible way, so it must be more expensive right? WRONG! A healthy 30 year old male non-smoker is going to pay about $35 a month for $500,000 worth of coverage on a mortgage insurance policy. It’s basically the exact same for a term policy; many times it’s actually more affordable.
Now looking at it side by side, apples to apples, you can clearly see there’s a few big differences. But by understanding the nuances of products that we take for granted, we can ensure that we make the best decisions for ourselves. There are many more issues around these two products than what can fit into a single article, so speak with your advisor and ask them to guide you through this process.
Aaron Koo is a passionate networker and entrepreneur who gets people out of that “someday” mentality about understanding their finances.
