Mortgage Protection Guide
“YOUR HOME MAY BE REPOSSESSED IF YOU DO NOT KEEP UP
REPAYMENTS ON YOUR MORTGAGE”
If you have an existing mortgage, or you are in the process of applying for one, you will have noticed the above statement shown prominently on all mortgage promotions and your offer letter. For this reason, such a long-term financial commitment warrants consideration of how to protect it.
There are two basic ways of protecting your mortgage:
- Insurance cover to clear your outstanding mortgage balance
- Protection of your monthly mortgage payments
This guide will explain the ways to insure both areas in turn.
Insurance protection for your outstanding mortgage balance
For most households, their mortgage is their single largest debt. It generally represents a significant, long-term obligation necessary to provide a family home. Mortgage Term Assurance Cover is designed to insure against loss that could prevent the loan from being paid off in full.
Term Life Assurance
Probably the most obvious form of Mortgage Term Assurance Protection is Life Cover, also known as Life Assurance or Life Insurance. It includes the word ‘term’ because you specify from the outset the number of years for which you require the policy. In the case of mortgage protection, a policy term equal to the remaining mortgage term should be chosen to ensure that there is no shortfall in the event of a claim. Quite simply, if you die within the policy term, it pays out a lump sum benefit.
Critical Illness Cover
In addition to Life Cover, a Critical Illness policy can be used to protect your mortgage balance. This can be arranged on its own, as a ‘stand alone’ policy, or linked to Life Cover, known as Death or Earlier Critical Illness Cover. In either event, the policy would payout on diagnosis of a specific medical condition or injury as defined by the policy.
Some Critical Illness Cover policies are more comprehensive than others though. To help you get to grips with this we’ve written a guide with a little more detail. (link)
Decreasing Term or Level Term Cover?
Decreasing Term Assurance – or DTA to give its acronym – is designed to decrease throughout the term roughly in line with your reducing mortgage balance as you gradually repay it. This is applicable for Repayment or Capital and Interest mortgages. It is not suitable for Interest Only mortgages.
When you take out a mortgage, you are provided with a projection showing how your mortgage balance will decrease over the term. As the majority of your repayments are made up of the interest element of the loan in the early years, this balance remains high to start with, dipping off towards the end of the term.
In order to calculate how much your policy would pay out at any point in the term, the insurance company uses a set interest rate and the same formula as your mortgage loan. Not necessarily the exact same rate though, as this could vary and change throughout your mortgage term. To ensure that there will be a sufficient sum to clear the balance, the policy benefit percentage is higher than a typical mortgage interest rate. They do vary though, typically from 6% to 12%, some are ‘set in stone,’ others allow you to choose the percentage when you take out the policy. In the latter case, choosing a higher interest rate attracts a slightly higher premium. This reflects that the higher the interest rate, the more benefit would be paid (from month 2 of the policy onwards).
There are some insurers who offer a ‘Mortgage Repayment Guarantee’ (Aviva / BG?). In this instance, the sum assured benefit will be exactly equal to the outstanding remaining mortgage balance at claim. However, a word of caution, these policies generally have a clause stating that any flexibility options that are taken advantage of – such as payment holidays and increased borrowing -void this guarantee. In that instance, a specific percentage will be defaulted to, often as low as 6%.
By contrast, a Level Term Assurance Policy will pay out the same sum assured benefit regardless of when you claim within the term. This type of cover is suitable protection for Interest Only mortgages, where the balance remains constant throughout the term.
When will it pay out?
The policy can be arranged to pay out on death only, diagnosis of a critical illness (as specified by the policy) or both – known as Death or Earlier Critical Illness Cover.
In any event, the policy will pay out as a tax free* lump sum (* note: “under current UK legislation”, inheritance tax liability may apply – link to article about trusts)
It’s always a good idea – albeit not a very pleasant one – to consider what you and or your family would need as a financial ‘cushion’ in the event of suffering a claimable event. For more information about different types of Term Assurance Cover, see our guides (link to Life Cover & Critical Illness Cover).
Protecting more than just your mortgage
Mortgage Term Assurance would mean that if you need to claim, your home is safe. But what if your family could no longer afford to live in it?
It’s not uncommon for people to increase their Mortgage Term Assurance Cover to reflect the fact that, in the event of a claim, they would need more money than that required to simply clear their mortgage balance. Some individuals do this by using a Level Term Assurance policy in place of a Decreasing Term plan so that there will be an additional amount of money on top of that required to pay the remaining mortgage balance. The difference in price between these two forms of Term Assurance is often negligible. However, although it’s commendable to identify the need for family or personal protection in addition to mortgage protection, it’s a good idea to look into protecting different needs separately.
There are several advantages to this approach but it all boils down to the fact that it’s better to insure specific needs with appropriate, suitable and specific cover.
We’ve developed a guide for family and personal protection to show how such cover can be of use. (LINKS)
Protecting your monthly mortgage payments
There are two main ways to protect your mortgage by ensuring that your monthly payments will continue to be paid if you are unable to:
- Protection that will payout if you are made redundant / unemployed
- Cover that will provide an income if you are unable to work due to ill health
Mortgage Payment Protection, also known as MPPI, can be arranged to protect both of these eventualities. This type of policy is also known as Accident, Sickness and Unemployment – or ASU – cover. Depending on the insurance provider, you can choose to have both elements protected – ASU, or just one – AS only or U only.
There are quite a few variations between providers of ASU / MPPI policies which make them difficult to compare, so it is beneficial to speak with an expert. To illustrate, here are just a few examples of areas and issues where ASU providers differ:
- Maximum monthly benefit permitted
- Unemployment cover for the self -employed
- Pre-existing conditions exclusions
- Blanket exclusions for common medical conditions
- Premiums based on age
- Initial exclusion period
- Non-smoker rates
- Annually reviewed policy term
- Additional cover for mortgage related expenses
- Own occupation cover
- Guaranteed premiums
- Free cover at start
- Unemployment only cover
- Premium price affected by occupation
- Premium price affected by address
Due to these and other factors, choosing the right cover for you can mean the difference between a policy paying out or not. Separate to this, selecting cover that fits with your circumstances can mean that one provider offers a better value option than another.
Other alternatives?
Where you have identified a need to protect your income due to the eventuality of being unable to work as a result of illness or injury, it’s generally a good idea to look into another type of cover known as Permanent Health Insurance or PHI. This is a more comprehensive type of cover which is not tied to your monthly mortgage repayments. It can be taken out as well as or instead of AS/MPPI cover. For more information, see our guide (LINK – Income protection cover)
When you speak with one of our consultants, we will identify which providers are suitable for your stated requirements and personal circumstances.