While it is not compulsory to have life insurance in place to get a mortgage it is an important consideration. No one likes to think about death, but how would your family cope with the bills and general living expenses if you were to die?
A mortgage is most likely the biggest expense you will leave behind. It is possible to get your mortgage debt covered cheaply by life insurance, but here is what you need to consider.
When do you need life insurance?
If you live with people who are a part of your life and rely upon your support to keep the roof over your heads, consider how they would cope if you were gone. That is where life insurance comes in. A life insurance policy can pay a lump sum or regular payments to your dependents if you die.
This means the big expenses such as childcare, household bills and even your mortgage can be covered, providing reassurance that your dependents won't struggle financially if you die.
Is life insurance necessary when buying a house?
Despite what your mortgage broker may tell you, the only insurance you require when purchasing a property is buildings insurance. This gives the lender certainty that the property they are lending against is protected and will cover the mortgage debt if the mortgage payer dies or becomes unable to keep up with the mortgage payments.
It is possible to get a life insurance policy that would cover the mortgage debt or one that just covers the monthly repayments, but regardless of what lenders and financial advisers may push, it is not compulsory to have either policy in place when borrowing money to buy a house.
Remember, the mortgage lender is usually quite confident that it will be able to recoup the money lent to you through sale of the house in a worst case scenario so life insurance is about protecting those who rely on that house as a home and not the lender.
Do I need life insurance to cover my mortgage if I live alone?
In some cases, such as if you are single and have no dependents, you may not need life insurance. If you were to die before repaying the mortgage, the mortgage balance becomes a debt against your estate and would have to be repaid, potentially using the assets within your estate, including your house, before these could be passed onto beneficiaries.
Normally the house would be sold to repay the debt unless there were other means within your estate to settle the mortgage debt. Some people in this situation prefer to buy life insurance to pay the mortgage off, so that their home can be passed on to their beneficiaries but you can see that it isn't essential.
More sensible products that benefit people with or without dependents, would be Income Protection, a policy that covers your income in the event that you are unable to work due to accident or sickness and critical illness insurance which pays a lump sum if you're diagnosed with a very serious illness like cancer, stroke or heart attack.
Do I need life insurance to cover my mortgage if I have children?
If you have dependents such as a partner or children or own a property with other people, it is a good idea to consider life insurance when taking out a mortgage as they may want to carry on living in it. You can choose a life insurance amount so that the payout would either clear or reduce the mortgage balance to a manageable amount for those left behind.
Do I need life insurance on a buy-to-let property?
Many landlords mistakenly believe the rental income on their buy-to-let portfolio will continue to be paid out to their dependents if they pass away, but if you were the only borrower on a buy-to-let mortgage and died, this debt (and the properties) forms part of your estate. All liabilities have to be settled during the probate process before assets can be distributed to your beneficiaries.
How can life insurance be used in estate planning?
Depending on the size of your estate, there may then be inheritance tax to pay as well. This is where you can be smart about how you arrange your life insurance to minimise your inheritance tax bill. You have two choices about how your life insurance is paid out and they will have different impacts on the way that the value of your estate will be calculated and what the inheritance tax bill will be.
|The way the value of your estate and potential inheritance tax is calculated|
|Life insurance without a trust||
|Life insurance with a trust||
Life insurance, when put in a trust could mean that your beneficiaries are able to receive monies to pay off or reduce the mortgage debt against your buy-to-let property so that they can continue to receive the rental income generated. A specialist life insurance adviser can help you to set up the trust at no extra cost.
Do I need life insurance if I don't have a mortgage?
A mortgage is likely to be your biggest monthly expense but you may have other financial commitments such as rent, utility bills, council tax, debt repayments, childcare costs. It is worth seeking financial advice and working out whether you would have enough savings in place or if you or your partner could survive financially if one of you was no longer around.
Often people forget to consider the impact if a non-working person in the household dies - this person may provide unpaid duties such as childcare, housekeeping and their death may mean that you have to either pay for these or change your work commitments to fill the gap. Either way, there is likely to be a financial impact that could be cushioned with appropriate life insurance.
In all these examples, whenever you take out life insurance you should also consider putting it into trust. This sets out who the payout should go to and excludes the amount from your estate, which should reduce any inheritance tax liability. You can split benefits between people and you can even nominate people who you trust to act as trustees so that the payout can be distributed in the way that you wish.
Remember, you don’t have to buy the life insurance that is offered by your mortgage broker or lender. Often they will be tied to a limited range of providers, so it is worth shopping around and speaking to an insurance specialist who can look at a range of products and find the best/cheapest product for you based on your health and financial circumstances. They can also help you with more complicated matters, like the aforementioned trust forms.
Do you need Income Protection insurance to get a mortgage?
No, there is no legal requirement to take out income protection insurance although it is a policy that everyone should consider when buying a new property. Income protection policies are much more likely to be claimed against than life insurance due to the higher likelihood that you may become incapacitated to work during your mortgage term.
An income protection policy provides a monthly tax-free payment if you are unable to work and can ensure that you are able to keep up the monthly repayments on your mortgage. You can read more about it in our article, "Income protection - do you really need it?"
Mortgage payment protection insurance
There is a product called mortgage payment protection insurance which is an insurance policy that just covers the cost of your monthly mortgage repayments should you become too ill to work. It usually only covers your mortgage payments for up to 12 months whereas income protection insurance can cover you until the mortgage is repaid. In instances where a person is not healthy enough to qualify for income protection, they may choose mortgage payment protection insurance on the understanding that most pre-existing health conditions are usually excluded for claims.
Life Insurance vs Mortgage Life Insurance vs Mortgage Protection Insurance
There are a few different types of life insurance to choose from if you want life insurance to cover your mortgage:
Life insurance is the overarching name given to a policy that pays out if you die. There a few different types but essentially they all pay out in the same event - death. The four main types of life insurance are:
- Level term assurance - the amount that you insure is paid as a lump sum if you die and it stays level for the number of years that you're insured for (the term) so that it doesn't matter if you die in the first of last year of the policy, it pays the same.
- Mortgage / Decreasing term assurance - the amount that you insure is paid as a lump sum if you die but it steadily reduces in the same way that a repayment mortgage reduces over the years that you have the policy (the term) so the amount paid out if you die does depend on which year of the policy you're in and how much is covered at that point.
- Family income benefit - this type of life insurance pays an income each year, for every year that is left of the policy from when the insured person dies until the policy ends.
- Whole of life insurance - this type of life insurance has no end date so it pays out when the insured person dies whenever that happens and is usually a fixed amount paid as a lump sum.
All of the above types of life insurance can be bought with an increasing option except the mortgage/decreasing term assurance. This means that the amount you choose to insure keeps increasing each year to keep up with inflation and your monthly premiums will increase too.
Working out which type of life insurance is right for you and your mortgage depends on what you want the money to do if you die.
Level term life assurance
This is the type of life insurance that you'll normally need if you have an interest-only mortgage. Interest-only mortgage balances don't reduce because the mortgage payer is only ever paying the interest acrueing against the amount that was borrowed. A level term life insurance can also be suitable for someone who wants a flat amount of life cover so that the money can be used for the mortgage or any other financial needs that might arise.
Mortgage term assurance / Decreasing term assurance / Mortgage life insurance / Mortgage protection insurance
These are the various names for a reducing type of life insurance where the cover reduces over the number of years the policy runs. It doesn't reduce in equal steps each year, instead it reduces slowly in the early years and faster in the later years to mimic how a repayment mortgage would reduce. Repayment or capital and interest mortgages charge a larger proportion of the interest in the early years of the mortgage, meaning that the amount of the debts reduces very little at this stage but this speeds up as the monthly payments start covering more and more of the mortgage balance in the later years.
Reducing life insurance that reduces alongside your mortgage balance is usually cheaper than a level life insurance where you're covered for the same amount throughout. It is only appropriate if you are trying to cover your repayment mortgage.
Family income benefit
This type of life insurance is designed to pay an income instead of a lump sum. If the person who is insured dies, the policy starts paying an income which will continue until the end date of the policy. It can be a more manageable way for people to keep paying their mortgage payments and even other bills if the worst happens. It is can cost less as well due to the decreasing risk of a large payout as time goes on. It won't provide a lump sum of money that the people in your life might need so can be bought alongside a policy that pays a lump sum to compliment it if needed.
'Whole of life'
Alternatively, you could get a whole-of-life policy that pays out no matter when you die, as long as you keep paying the monthly premiums. They're usually more expensive and because your mortgage will usually run for a finite number of years, most people don't need this type of policy to protect their mortgage.
A whole of life insurance is usually needed if the money from the payout will always be needed, regardless of when you die. For example, if you wanted to fund the inheritance tax payable on your estate when you die, you may need this type of life insurance.
Mortgage life insurance v level term life insurance
It is important to note the differences between level term life insurance and mortgage life insurance to work out which will be more suitable for you.
|Type of life insurance||Pros||Cons|
|Mortgage/decreasing term assurance||
|Level term assurance||
How to decide which is best for you?
There are plenty of factors that will determine what sort of life cover is best for you. If you have a mortgage and dependants, it is worth considering mortgage life cover so your loved ones can go on living in the property with the debt paid off if you pass away. But if you can get large enough life cover for the mortgage debt as well as any other living expenses, this may also be sufficient to ensure your family is looked after.
The monthly premium will depend on your age, occupation, lifestyle, health, as well as the provider you use, but generally it can cost as little as a few pence per day.
Remember, life insurance will usually only cover death and there are other sorts of cover such as mortgage payment protection insurance, critical illness and income protection that can provide payouts to cover a mortgage and other expenses if someone is unable to work either permanently or temporarily. This will depend on certain conditions and exclusions.
It is also worth checking the benefits offered by your employer as some companies offer death in service benefits or pension payouts if someone dies while employed.
A financial adviser or life insurance specialist can help navigate all these scenarios and put a plan in place to ensure your mortgage can be covered in the event of death. It is worth consulting a specialist life insurance broker to compare mortgage life insurance quotes as they will be able to recommend the best policy (or policies) for you based on your circumstances and health. Simply click on the link to complete the short form for a callback at a time that suits you. Additionally, if you take out a policy you will qualify for up to £100 cashback.
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