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Buying a home can be expensive. When you take out a mortgage loan, it may take you 30 years to repay the debt via monthly mortgage payments. But what happens if you pass away unexpectedly before the loan is paid in full?
To help your family with financial burdens like a mortgage in the event you die, it’s a smart idea to get life insurance with sufficient coverage.
Learn more about how life insurance works, how it can safeguard your survivors, choosing the right type of policy and coverage level, and more.
What's in this Article?
Essentially, life insurance is a contract between an insurance company and a policyholder (you). In exchange for premiums you pay annually, quarterly, or over other intervals, the insurer will pay a lump sum, known as a “death benefit,” to your named beneficiaries if you pass away while the policy remains in effect.
The funds can be used for any purpose, including making the mortgage payment, or paying off the mortgage entirely, if the payout is high enough.
Life insurance probably isn’t the first thing on new homeowners’ minds. Homeowners insurance, sure. You can’t close without that. But for first-time homebuyers in particular, who are relatively young and healthy, life insurance may seem like a worry for another day — one well into the future.
But life insurance is important even if you expect to live for many more decades. Accidents and illness happen, and not having life insurance could put your family in a devastating financial position, including when it comes to your house.
Life insurance is designed to provide financial protection to your beneficiaries – which often means your spouse, children, and others who depend on you for financial support. If you are the primary earner in your household and you have a mortgage loan, your family could be on the hook for repayment of that loan if you were to die.
Your loved ones may be forced to sell your home if they cannot afford the mortgage payments, property taxes, or other debts you leave behind.
Getting a life insurance policy can eliminate this risk.
If your policy has sufficient coverage, your beneficiaries will receive a cash payout that can be used to pay off your home or continue making monthly mortgage payments. The death benefit can also be used toward other home expenses your survivors need money for – including home maintenance and repair bills or remodeling.
“Life insurance is useful for anyone who expects to have financial obligations that outlive them, such as a mortgage or higher education expenses for their children,” explained Brian Martucci, finance editor for Money Crashers. “Additionally, some types of life insurance policies, such as a permanent whole life policy, serve as relatively low-risk investment instruments that build cash value over time, eventually turning into valuable assets that policyholders can borrow against or cash out during their lives.”
Chuck Czajka, founder of Macro Money Concepts, a financial firm in Stuart, Fla., agreed that obtaining life insurance is a smart strategy.
“Over your life, you have an economic value to your loved ones. You will earn money over your lifetime to support the lifestyle you’ve created. So you have to look at life insurance as a leverage product – you pay a premium in exchange for a death benefit that your survivors will receive,” says Czajka.
There are several different types of life insurance policies, each of which offers pros and cons.
Term life insurance
This policy provides coverage for a defined amount of time, during which your annual premium payments remain fixed. Typical policy lengths are 10, 15, 20, 25, or 30 years, or to a specific age, like age 80.
If you, the insured policyholder, pass away within the term length you choose, your beneficiaries can make a claim and receive the death benefit money tax-free.
“The advantages are that you’ll pay lower premiums with term life insurance, your beneficiaries usually receive larger payouts, and this type of policy can, in certain instances, be converted to whole life insurance if you so choose,” said Lia Easler, Associate Vice President at Nationwide Insurance.
Whole life insurance
A whole life insurance policy offers a fixed death benefit as well as a cash value component that accrues interest at a guaranteed rate of return. Many whole life insurance policies also pay out dividends that can be used to decrease premium payments or add to your cash value.
The premium amount you pay annually remains fixed over the life of the policy, which typically remains in place as long as you live.
“This insurance coverage remains in effect indefinitely until you die, cash out the policy, or reach age 100,” Martucci explained. However, the premiums for whole life insurance can be more expensive than those for term life insurance policies, and the death benefit can be smaller as well.
Universal life insurance
A universal life insurance policy provides more flexibility than a whole life policy, as you get the advantage of a cash component but you may be able to adjust your premium payments and death benefit. However, universal policies can be more volatile.
The amount of your cash value will depend on the performance of assets within your account and the interest earned at prevailing rates. “A universal life policy doesn’t have the guaranteed level premium available with a whole life policy,” Fox said. “Variable rates also mean that interest on your cash value could be low. And your policy usually needs to have a positive cash value to remain active.”
The amount of life insurance coverage – specifically your death benefit payout – you need will depend on several factors, such as the financial needs of your survivors if you were to pass away.
To determine how much life insurance coverage is appropriate for your family, consider the following:
- Remaining balance of your mortgage
- Monthly mortgage payments
- Other unpaid debts they’d be responsible for
- Utility bills
- Ongoing expenses, such as medical costs and prescriptions
Experts recommend crunching the numbers carefully and consulting with a life insurance agent or broker to determine your family’s insurance needs.
An insurance agent can recommend appropriate life insurance products, with an insurance payout commensurate with your loved ones’ financial obligations. You can also request life insurance quotes directly from insurance companies, though working with an agent may be easier, since they can run the numbers with different providers for you.
Mortgage protection insurance (MPI) is a kind of life insurance, but it’s specific to your mortgage loan.
Standard life insurance pays out a death benefit to your heirs, who can then use the money any way they choose. MPI gets paid directly to your lender to pay off your mortgage balance.
Some homeowners may opt to take out MPI so they know that their mortgage will be paid off and their families won’t face the decision of whether to use life insurance funds to pay off the home or make monthly mortgage payments.
MPI can add a second layer of financial protection and peace of mind for your loved ones, but it is not a replacement for standard life insurance and should not be treated as such. Life insurance pays out a death benefit that can be used for non-housing expenses, including college tuition, debt repayments, or day-to-day expenses and family needs.
Life insurance for homeowners: FAQs
Yes, especially if they are the primary breadwinner or have dependents. A life insurance policy pays out a death benefit to your designated heirs, and they can use that money to pay off the mortgage balance or continue making monthly mortgage payments on the home.
A mortgage protection insurance policy pays off your mortgage balance if the policyholder dies. The insurance company sends the payout directly to your mortgage lender, rather than to your heirs.
The downside to mortgage protection insurance is that you can only use the payout for one thing: to pay off the mortgage. Life insurance, on the other hand, can be used to pay off the mortgage OR any other expense in the event that the insured person passes away.
As a new homeowner, you don’t want to think about death. You want to focus on making memories with your family for years to come.
But life insurance provides peace of mind and can allow you to be more present for those memories, knowing that whatever happens, your loved ones can stay in the home you’ve created together.
Some references sourced within this article have not been prepared by Fairway and are distributed for educational purposes only. The information is not guaranteed to be accurate and may not entirely represent the opinions of Fairway.