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?