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.
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.
“Beneficiaries can use the money for whatever purpose they choose. Often, this includes paying everyday bills, mortgage payments, or putting a child through college,” said Tony Fox, director of Channel Development for Evive, a Chicago-based data analytics provider to the healthcare industry.
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.
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 when you’re younger with term life insurance, your beneficiaries usually receive larger death payouts, and this type of policy can, in certain instances, be converted to whole life insurance if you so choose,” Fox said.
“But term life insurance requires you to requalify at the end of the term, which can be difficult to do as you get older and may have more health issues,” he added. “Premiums can go up every time you take out a new term, and the policy accumulates no cash value.”
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.”
Variable life insurance
With this option, payout amounts are based on the performance of the underlying securities on the policy, which you get to select. These policies will yield a higher return when the market is up and a lower return when the market is down.
Given this volatility, a variable life insurance policy is best for those who can tolerate the additional risk involved. The benefits of this policy are that you can potentially earn more than with other types of permanent life insurance, and your death benefit won’t decrease so long as you make your minimum premium payments on time. You also get a certain level of control over how your cash value is invested, and you can allocate your funds according to your own risk tolerance.
“On the downside, you may experience a decrease in your cash value due to poor performance of your investment options,” Fox cautioned.
He added that the fees for variable life insurance can also be higher than with a universal life insurance policy.
And, “a variable policy is typically subject to surrender charges for up to 15 years, depending on the carrier, which can be very high in the policy’s early years,” he said.
Surrender fees are essentially penalties you’ll pay for cancelling your insurance policy early.
No medical exam life insurance
A no-medical-exam life insurance policy is an option for people who have ongoing medical issues that might prevent them from being approved for other types of life insurance. These policies don’t require a medical exam as a condition of underwriting, but life insurance companies may still consider your family health history and personal medical information in determining whether to issue coverage and how to set premiums.
“A guaranteed issue no-exam policy will typically offer smaller death benefits, but applicants cannot be turned down for medical reasons, which can be an advantage to some with pre-existing health conditions,” Martucci said.
Term life insurance is the most common and affordable type of life insurance, particularly among policyholders who view it as a hedge against the relatively low likelihood of premature death.
“But permanent whole life policies are a better fit for policyholders seeking long-term financial flexibility with relatively low risk,” Martucci added.
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.
As with any type of financial product or policy, it pays to do your homework and shop around when it comes to life insurance.
“Premiums for seemingly identical policies can vary significantly by insurer, so always get multiple quotes from different insurance companies during your initial shopping period,” recommended Martucci.
Additionally, opt for a medical exam if requested or required, unless you have good reason to expect an unfavorable result.
“No-exam policies always have higher premiums than equivalent standard policies,” Martucci said.
Unless you have a medical condition that will prevent you from qualifying for a standard policy, it’s a good idea to provide the information needed for a term or whole policy so you can know what the most affordable options are.
You may also be able to save money if you pay your premiums annually and put a policy into effect when you’re younger versus older, Fox suggested.
Lastly, “look to see if your employer offers a life insurance policy as an employee benefit before shopping for one on your own. Life insurance offered through your employer offers a leveraged, negotiated rate that is often better than what an individual might expect to be offered,” he added.
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.