Just Say No To Mortgage Life Insurance

When people get a mortgage, it’s often the impetus that motivates them to take a closer look at their whole financial picture.

They’re worried about a few things. They want to make sure they have enough to afford the house as well as a comfortable retirement. Nobody wants to become house poor. And at the same time, they want to make sure their significant other doesn’t get burdened with an unreasonably expensive debt if they accidentally pass away.

The folks setting up the mortgage know this is a perfect time to try and convince a borrower mortgage life insurance is for them. What better time to remind someone about insurance than right after they sign up for a very long-term commitment?

That’s exactly what they’re counting on. Here’s why you need to say no to mortgage life insurance.

Two big issues

The first big problem with mortgage life insurance is how the product is structured.

It’s a pretty simple product. Borrowers take out a policy which automatically pays out the value of the mortgage if they die. It stays in place for as long as the mortgage is in place, usually 25 years. Payments stay the same throughout the mortgage, slowly getting cheaper as inflation erodes the value of a dollar. And they don’t (usually) have to take a medical exam. They just need to answer a few health questions and they’re good to go.

For the insurance company, this is a great deal. What they do is price the policy based on the value of the mortgage. Each month, as the mortgage goes down, their potential liability goes down as well. After a decade or more, the amount insured really takes a hit as the borrower has paid off the mortgage.

By the end of the mortgage, a borrower might be paying $50 per month for only $25,000 or $50,000 in life insurance. That’s a real crummy deal.

Insurance models are pretty simple. Your chances of dying go up as you age. With mortgage life insurance, the amount of insurance outstanding goes down as the chance of dying goes up, while the monthly premium stays the same.

That’s a great product for the insurance company, but no so much for the person paying every month.

The other issue is how the policy is processed when one of the holders dies. Normal life insurance underwrites the policy before it goes into effect. That’s why you have to have a medical exam before the company will insure you.

A typical mortgage life insurance policy is different. They don’t begin to underwrite the policy until after the policyholder dies.

This can create some issues. Remember those simple health questions asked on the mortgage life insurance application form? Once the policyholder dies, the insurance company goes out of their way to prove the applicant wasn’t being truthful.

The most common one is smoking. If the insurance company can prove somebody who said they were a non-smoker lit up recently, it can be enough to deny the payout. The insurer can claim it would have never insured the policyholder if they knew they were a smoker.

I’ve even heard policies be denied because of heartburn. Somebody goes to the doctor because they’re experiencing chest pains that turn out to be a nasty case of heartburn. They tell the mortgage life insurer they haven’t been checked out for heart issues. When the insurance company completes their investigation they deny the claim because perhaps the doctor messed up the heartburn diagnosis.

Now to be clear, my understanding is most of these policies to pay out what’s promised. There’s just a small chance of a payout being rejected. Still, the risk exists.

A better solution

The solution is simple. Just buy a traditional life insurance policy.

A traditional policy will stay constant in value, which protects the borrower better than the declining balance model of a mortgage life insurance policy. And if borrowers are concerned about over insuring themselves after say 15 or 20 years, they can take out a shorter term life insurance policy that covers the riskiest years. They can then choose to go without insurance when the mortgage value goes down, or get a smaller policy.

And a traditional policy will be much more iron-clad. After a medical exam it’s much harder for an insurer to claim they didn’t know about a health issue.

A traditional policy tends to be sold by a life insurance professional who works with dozens of different insurers. Mortgage life insurance policies are sold by loan officers and mortgage brokers. Who would you rather buy insurance from?

Is Private Mortgage Insurance a Good Idea?

 

Private mortgage insurance, commonly referred to as PMI, is insurance which borrowers have to pay in case they cannot afford to pay a 20% down payment. As a borrower, it will cost $50 to $80 monthly. Mortgage insurance reimburses the lender if you default on your home loan. However, it can sometimes become a burden for the borrowers, especially if they do not proceed carefully. As it is based on a percentage of the mortgage loan, borrower is expected to pay each month, it varies depending on borrower’s credit risk and the size of his home loan.

2 Types of Private Mortgage Insurance

Private Mortgage Insurances can be classified into 2 broad categories – Borrower-paid PMI and Lender-paid PMI.

Borrower-paid Private Mortgage Insurance

This type of PMI is where the borrower has to pay insurance premium. Usually, borrower is required to purchase this insurance policy when he is unable to afford the 20% down payment on his home loan. It is also known as Traditional Mortgage Insurance.

Lender-paid Private Mortgage Insurance

The lender-paid PMI is the type where the lender pays the PMI premium cost of PMI but the borrower must bear the premium cost. Most lenders tend to add the extra expense of premium cost to the mortgage loan interest. Lender generally buys the lender-paid PMI policy for high loan-to-value mortgage.

Advantages of Private Mortgage Insurance for the Borrower

It has been established that there are risks associated with private mortgage insurances for the borrowers, which will be discussed in details in a later section. However, there are some up-sides of these insurances as well. One of the biggest reasons why borrowers choose this is because it allows the low income borrowers or borrowers who are in need for large amount of fund the opportunity to buy a home.  Even when the borrowers can pay only a small percentage of the total cost, they can but the home.

In addition to providing shelter, this also helps build equity. They are able to enjoy all benefits as homeowners.

 

Disadvantage of Private Mortgage Insurance and Ways to Avoid Them

While is seems like a great idea for both lenders and borrowers, there are some downsides associated with PMIs. As a borrower, you may have to pay for a longer period than expected. Some lenders may require you to maintain a PMI contract for a fixed period of time. So, even after you meet the 20% threshold, you may be obligated to continue paying for the insurance.

These insurances are hard to cancel and eliminating the monthly burden is not as easy. The lender might want you to to draft a letter requesting to cancel the PMI. Depending on the lender, the process may take a few months.

Ways to Avoid Risks of Personal Mortgage Insurance

Even though the risks are evident, more and more people are getting personal mortgage loans. They cave in to their financial needs. There are 3 main ways to avoid the risks associated with personal mortgage insurances. They are:

  • Make a down payment which is equal to minimum 20% of the home’s purchase price.
  • Rely on a piggyback mortgage
  • Get a lender-paid mortgage insurance

It is true that Private mortgage insurances are expensive. If you are not confident that you will be able to get 20% equity in the home in a few years, it is suggested to either consider a piggyback loan or give a larger down payment. piggyback loans might be riskier than traditional alternatives but they are tax deductible.  

Before making the final decision, assess both the positives and negatives of getting a Private Mortgage Insurance.