Mortgage Life Insurance
Encyclopedia
Mortgage Life Insurance is a form of insurance
specifically designed to protect a repayment mortgage
. If the policyholder were to die while the mortgage life insurance was in force, the policy would pay out a capital sum that will be just sufficient to repay the outstanding mortgage
.
Mortgage life insurance is supposed to protect the borrower's ability to repay the mortgage for the lifetime of the mortgage. This is in contrast to Private mortgage insurance
, which is meant to protect the lender against the risk of default
on the part of the borrower.
Some mortgage life insurance policies will also pay out if the policyholder is diagnosed with a terminal illness
from which the policyholder is expected to die within 12 months of diagnosis. Insurance companies sometimes add other features into their mortgage life insurance policies to reflect conditions in their country’s domestic insurance market and their domestic tax
regulations.
which paradoxically declines in value as the client-borrower pays more premium to the insurer. In many cases, traditional life insurance
(whether term
or permanent
) can offer a better level of protection for considerably smaller premiums.
The biggest advantage of traditional life insurance over mortgage life insurance is that the former maintains its face value
throughout the lifetime of the policy, whereas the latter promises to pay out an amount equal to the client's outstanding mortgage debt at any point in time, which is inherently a decreasing sum. Hence, mortgage life insurance is extremely profitable for lenders and/or insurers and equally as disadvantageous to borrowers.
In addition, lending banks often incentivise borrowers to purchase mortgage life insurance in addition to their new mortgage by means that are on the verge of tied selling practices. Tied selling of a product of self or of an affiliated party, however, is illegal in most jurisdictions
. In Canada
, for example, this practice is explicitly forbidden by Section 459.1 of the Bank Act
(1991).
Finally, mortgage life insurance is not required by law. It is up to the client-borrower whether he or she will opt to protect his or her property investment by an insurance product or not. Similarly, the choice of insurer is completely unrestrained as well.
Because of these suboptimal qualities of mortgage life insurance, the product has been subject to sharp criticism by financial experts and by the media
across North America
for over a decade. This has arguably led to fewer banks actively advertising this product in the recent years, although many still keep it in their portfolios. However, many critics fail to consider that in many cases where term life insurance is denied for health reasons, mortgage life insurance is still available. As such, mortgage life insurance can cover the biggest expense left by a deceased breadwinner - ie housing costs. Thus, it is simplistic to dismiss it out of hand as disadvantageous to borrowers.
. Private mortgage insurance protects the lender instead of the borrower, although its premiums are payable by the borrower. This type of insurance is compulsory in certain jurisdictions for mortgages started with low down payments
.
In the United States
, subject to Homeowners Protection Act of 1998, a borrower who provides less than 20% down payment up front may be required to pay for private mortgage insurance until he or she has paid up at least 80% of the mortgage’s outstanding value.
Insurance
In law and economics, insurance is a form of risk management primarily used to hedge against the risk of a contingent, uncertain loss. Insurance is defined as the equitable transfer of the risk of a loss, from one entity to another, in exchange for payment. An insurer is a company selling the...
specifically designed to protect a repayment mortgage
Repayment mortgage
A repayment mortgage is a term generally used in the UK to describe a mortgage in which the monthly repayments consist of repaying the capital amount borrowed as well as the accrued interest, so that the amount borrowed decreases throughout the term and by the end of the loan term has been fully...
. If the policyholder were to die while the mortgage life insurance was in force, the policy would pay out a capital sum that will be just sufficient to repay the outstanding mortgage
Mortgage loan
A mortgage loan is a loan secured by real property through the use of a mortgage note which evidences the existence of the loan and the encumbrance of that realty through the granting of a mortgage which secures the loan...
.
Mortgage life insurance is supposed to protect the borrower's ability to repay the mortgage for the lifetime of the mortgage. This is in contrast to Private mortgage insurance
Lenders mortgage insurance
Lenders Mortgage Insurance , also known as Private mortgage insurance in the US, is insurance payable to a lender or trustee for a pool of securities that may be required when taking out a mortgage loan...
, which is meant to protect the lender against the risk of default
Default (finance)
In finance, default occurs when a debtor has not met his or her legal obligations according to the debt contract, e.g. has not made a scheduled payment, or has violated a loan covenant of the debt contract. A default is the failure to pay back a loan. Default may occur if the debtor is either...
on the part of the borrower.
The Mechanics
When the insurance commences, the value of the insurance cover must equal the capital outstanding on the repayment mortgage and the policy’s termination date must be the same as the date scheduled for the final payment on the repayment mortgage. The insurance company then calculates the annual rate at which the insurance cover should decrease in order to mirror the value of the capital outstanding on the repayment mortgage. Even if the client is behind on repayments, the insurance will normally adhere to its original schedule and will not keep up with the outstanding debt.Some mortgage life insurance policies will also pay out if the policyholder is diagnosed with a terminal illness
Terminal illness
Terminal illness is a medical term popularized in the 20th century to describe a disease that cannot be cured or adequately treated and that is reasonably expected to result in the death of the patient within a short period of time. This term is more commonly used for progressive diseases such as...
from which the policyholder is expected to die within 12 months of diagnosis. Insurance companies sometimes add other features into their mortgage life insurance policies to reflect conditions in their country’s domestic insurance market and their domestic tax
Tax
To tax is to impose a financial charge or other levy upon a taxpayer by a state or the functional equivalent of a state such that failure to pay is punishable by law. Taxes are also imposed by many subnational entities...
regulations.
The Controversy
Based on the mechanics of the product, mortgage life insurance is a financial productFinancial services
Financial services refer to services provided by the finance industry. The finance industry encompasses a broad range of organizations that deal with the management of money. Among these organizations are credit unions, banks, credit card companies, insurance companies, consumer finance companies,...
which paradoxically declines in value as the client-borrower pays more premium to the insurer. In many cases, traditional life insurance
Life insurance
Life insurance is a contract between an insurance policy holder and an insurer, where the insurer promises to pay a designated beneficiary a sum of money upon the death of the insured person. Depending on the contract, other events such as terminal illness or critical illness may also trigger...
(whether term
Term life insurance
Term life insurance or term assurance is life insurance which provides coverage at a fixed rate of payments for a limited period of time, the relevant term. After that period expires coverage at the previous rate of premiums is no longer guaranteed and the client must either forgo coverage or...
or permanent
Permanent life insurance
Permanent life insurance is a form of life insurance such as whole life or endowment, where the policy is for the life of the insured, the payout is assured at the end of the policy and the policy accrues cash value....
) can offer a better level of protection for considerably smaller premiums.
The biggest advantage of traditional life insurance over mortgage life insurance is that the former maintains its face value
Par value
Par value, in finance and accounting, means stated value or face value. From this comes the expressions at par , over par and under par ....
throughout the lifetime of the policy, whereas the latter promises to pay out an amount equal to the client's outstanding mortgage debt at any point in time, which is inherently a decreasing sum. Hence, mortgage life insurance is extremely profitable for lenders and/or insurers and equally as disadvantageous to borrowers.
In addition, lending banks often incentivise borrowers to purchase mortgage life insurance in addition to their new mortgage by means that are on the verge of tied selling practices. Tied selling of a product of self or of an affiliated party, however, is illegal in most jurisdictions
Jurisdiction
Jurisdiction is the practical authority granted to a formally constituted legal body or to a political leader to deal with and make pronouncements on legal matters and, by implication, to administer justice within a defined area of responsibility...
. In Canada
Canada
Canada is a North American country consisting of ten provinces and three territories. Located in the northern part of the continent, it extends from the Atlantic Ocean in the east to the Pacific Ocean in the west, and northward into the Arctic Ocean...
, for example, this practice is explicitly forbidden by Section 459.1 of the Bank Act
Canada Bank Act
The Bank Act is an Act of the Government of Canada respecting banks and banking.The Act groups banks in three schedules. Schedule I banks are banks allowed to accept deposits that are not a subsidiary of a foreign bank, Schedule II banks are banks allowed to accept deposits that are a subsidiary...
(1991).
Finally, mortgage life insurance is not required by law. It is up to the client-borrower whether he or she will opt to protect his or her property investment by an insurance product or not. Similarly, the choice of insurer is completely unrestrained as well.
Because of these suboptimal qualities of mortgage life insurance, the product has been subject to sharp criticism by financial experts and by the media
Mass media
Mass media refers collectively to all media technologies which are intended to reach a large audience via mass communication. Broadcast media transmit their information electronically and comprise of television, film and radio, movies, CDs, DVDs and some other gadgets like cameras or video consoles...
across North America
North America
North America is a continent wholly within the Northern Hemisphere and almost wholly within the Western Hemisphere. It is also considered a northern subcontinent of the Americas...
for over a decade. This has arguably led to fewer banks actively advertising this product in the recent years, although many still keep it in their portfolios. However, many critics fail to consider that in many cases where term life insurance is denied for health reasons, mortgage life insurance is still available. As such, mortgage life insurance can cover the biggest expense left by a deceased breadwinner - ie housing costs. Thus, it is simplistic to dismiss it out of hand as disadvantageous to borrowers.
Private Mortgage Insurance
The term Mortgage insurance may in some contexts refer to Private mortgage insurance (PMI), also known as Lenders mortgage insuranceLenders mortgage insurance
Lenders Mortgage Insurance , also known as Private mortgage insurance in the US, is insurance payable to a lender or trustee for a pool of securities that may be required when taking out a mortgage loan...
. Private mortgage insurance protects the lender instead of the borrower, although its premiums are payable by the borrower. This type of insurance is compulsory in certain jurisdictions for mortgages started with low down payments
Down payment
Down payment is a payment used in the context of the purchase of expensive items such as a car and a house, whereby the payment is the initial upfront portion of the total amount due and it is usually given in cash at the time of finalizing the transaction.A loan is then required to make the full...
.
In the United States
United States
The United States of America is a federal constitutional republic comprising fifty states and a federal district...
, subject to Homeowners Protection Act of 1998, a borrower who provides less than 20% down payment up front may be required to pay for private mortgage insurance until he or she has paid up at least 80% of the mortgage’s outstanding value.