Shortly after you close on a mortgage, whether it’s because you just bought a home or refinanced your existing loan, you’ll probably start getting daily solicitations in the mail urging you to purchase mortgage protection life insurance.
These solicitations disguise themselves as official requests from your mortgage lender with details about your mortgage, like your lender’s name, how much you borrowed, your loan type and, of course, your name and address. In stern, bold lettering, they lead with statements like these:
- “IMPORTANT NOTICE: PLEASE COMPLETE AND RETURN”
- “FINAL NOTICE: MORTGAGE PROTECTION CARD”
- “NOTICE OF OFFERING: MORTGAGE FREE HOME PROTECTION”
Then they get into the scare tactics and emotional pleas:
“What if you die suddenly? Would your family be able to continue paying the mortgage and maintain the same quality of life?”
The solution they offer is a program claiming to “protect your family in case of an unexpected tragedy by paying off your mortgage.” It’s called a mortgage protection program or mortgage protection life insurance. “Without this plan,” the solicitations say, “your family would still have to make your monthly mortgage payments.”
But mortgage protection insurance (MPI) is really just a type of life insurance. It’s sold by banks affiliated with lenders and by independent insurance companies that can obtain information about your mortgage from public records. Policy terms and conditions vary by state and by insurance company; the information provided here is meant to be a general overview and may not precisely reflect the terms of any specific policy. That being said, most people don’t need mortgage protection life insurance. Here's why, plus information on who might actually benefit from having one of these plans.
No Flexibility (Maybe)
With regular term life insurance, your survivors or caretakers can use the money they receive as they see fit. Under some traditional-style mortgage protection insurance policies – particularly those purchased through your lender – the insurer sends the benefit payment directly to your lender so your beneficiaries never see it at all. A better option is a mortgage protection policy that pays your loved ones directly. More and more policies do, so be sure that's the kind you get if you choose this product.
If you’re healthy and have never used tobacco, you’ll usually pay more for coverage when you get mortgage protection insurance than you would for term life insurance.
“The main reason for not buying the MPI is the cost,” says Bakul Modi, an insurance adviser at Protection from Life in the Raleigh-Durham, N.C. area. “It typically offers a declining amount of coverage for a cost that is higher than a term policy. You can get level term protection for a lower cost with term insurance.”
Unlike other types of insurance, it’s difficult to get a quote for mortgage protection insurance online. Prices for mortgage protection insurance can vary widely; there is less transparency in this market and there are too many variables to accurately compare prices, Modi says. But here is one example of the difference in payment: For a 35-year-old male nonsmoker living in New York, a 30-year mortgage life insurance policy from State Farm might cost $755 per year. If he qualified for the best rates on a 30-year term life insurance policy, he might pay $345 per year; if he qualified for the worst rates on the same policy, he might pay $677.50 per year. These prices are subject to underwriting, which may require a medical exam.
What’s more, the premiums on the mortgage protection policy might only be fixed for the first five years; with that kind of policy, they could then go up or down. You’ll have to consult the policy to see how high the premiums could get. By contrast, the term policy has fixed premiums for 30 years; no surprises or price increases.
Shrinking Payout (If You Buy the Wrong Kind)
Many mortgage protection policies do offer level premiums for the policy’s duration, meaning that your premiums will stay the same. This feature sounds great – except that with many policies the coverage these consistent premiums buys you will shrink over time as the potential payout decreases. This type of mortgage protection life insurance is referred to as “decreasing term” insurance.
Here's the reasoning: The insurance is designed to pay off your mortgage balance, and each month, you pay down part of your mortgage principal. Therefore, the mortgage protection insurance policy’s potential payout shrinks every time you pay your mortgage.
Instead, look for the newer type of mortgage protection product where the payout doesn’t decline; this feature is called a level death benefit. What it means is that if you're covering a $100,000 mortgage, your beneficiary (not the lender) will receive the whole $100,000, even if the mortgage debt has declined to $65,000. If you pay off the mortgage while the policy is still in effect, some policies allow you to convert your mortgage insurance into a life insurance policy.
Returned (But Inflation-Eroded) Premiums
Some mortgage protection insurance policies will return your premiums if you never file a claim. Does this make up for the fact that your coverage declines although you keep paying the same amount? Not really. After 15 or 30 years, when your mortgage is paid off and you get your premiums back, they’ll be worth far less because inflation will have eroded their value. You also will have lost the opportunity to invest what you saved from purchasing cheaper term life insurance instead of mortgage protection insurance. That’s 15 or 30 years of potential compounding returns down the drain.
So Who Might Benefit?
Some people don't qualify for term life insurance because of their medical history or current poor health – and aren’t eligible for a group policy that doesn’t require medical underwriting (employer life insurance may not require a medical exam, for example). For these individuals, mortgage protection insurance could be a useful alternative. .
“MPI is usually sold without underwriting,” Modi says, “so if you are unable to get term, MPI might make sense.”
If that fits your situation, get quotes from several companies – not necessarily the ones that sent you the alarming letters through the mail. Any time you purchase insurance, check the firm’s financial strength rating with A.M. Best, a company that gives insurers a letter grade to help consumers evaluate whether the insurer will be able to pay them if they file a claim.
To avoid a declining-payout MPI policy, you might be better off with a no-medical-exam (also called “guaranteed issue”) term policy with level premiums and a level death benefit. These policies cost more and sometimes have lower coverage than term policies that review your health and medical history, but they’ll pay the same benefit whether you die 5 or 25 years into your mortgage.
Another possibility: Mortgage protection insurance could offer more coverage at a better price earlier in your mortgage term, but once you’ve paid down the principal significantly, you might be better off switching to a guaranteed issue term policy.
“If you cannot qualify for term insurance, be sure to shop around,” Modi says. Compare the fine print to see what you’re really getting for your money. “While there are scams out there, it is a legitimate, albeit expensive, product,” he says. “Not all policies are equal.”
Here are two more important considerations if you're considering MPI:
Like many other types of life insurance, mortgage protection insurance may not be available after a certain age. State Farm, for example, only offers 30-year mortgage protection insurance to applicants age 45 or younger; the age limit is 36 in New York. You’ll need to be 60 or younger to get a 15-year policy.
Don't Confuse It With Private Mortgage Insurance
While the names sound similar, mortgage protection insurance and private mortgage insurance are completely different products. Private mortgage insurance protects the lender, not you. If you put down less than 20% on your home, you pay monthly premiums to a PMI policy that will pay your lender if you default. If you die, your heirs will continue to owe the mortgage payments and would have to default on them before PMI kicks in. If anyone depends on your income, be sure that you purchase life insurance to help them pay the mortgage and other expenses after your death.
The Hard Sell
Mortgage protection insurance companies might try to convince you that you need their product in addition to life insurance. They’ll tell you that paying off the mortgage will eat up a major portion of your life insurance proceeds, leaving much less for your survivors to meet their basic living expenses. But if you don’t think you have enough life insurance, you should buy more; it will probably cost less to increase that coverage than to purchase a separate mortgage protection policy. The other flaw in this argument’s logic is that your survivors would need to pay off the mortgage if you died unexpectedly. That isn’t always the case and isn’t necessarily the best use of insurance proceeds.
The Bottom Line
Financial experts usually don’t recommend any insurance product that only pays certain bills. If you’re concerned about your spouse or children inheriting a mortgage they might not be able to pay, term life insurance is the best option for those who qualify. Even though some policies are more flexible now, people should heavily research term insurance and other options before choosing mortgage protection life insurance.