How Does Mortgage Protection Life Insurance Work?
Purchasing your first home is one of life’s major milestones — right up there with graduating from college or getting your first real job. And as with those other big life moves, the home purchase comes with a host of decisions to make. One of those decisions is whether to sign up for the mortgage protection life insurance offered by your home lender.
How does mortgage life insurance work?
Mortgage protection life insurance, also called MPI, pays off your home loan balance if you die. Some policies additionally have temporary disability or job loss benefits under which the insurer makes your mortgage payments for a year or two if you become disabled or unemployed. You may also be able to access some of your death benefit if you are diagnosed with a terminal illness. Additionally, some insurers offer an add-on rider that returns a portion of premiums to you after a certain period of time if there’s no claim against the policy.
Mortgage protection life insurance vs. private mortgage insurance
With all the paperwork being shuffled around as you work towards closing your home purchase, it’s easy to confuse mortgage protection insurance with private mortgage insurance or PMI. PMI is often required by your lender if your home down payment is less than 20% of the purchase price. This type of insurance protects the lender in case you default on the loan. Note that PMI offers no protections for you. If you have PMI and you default, you still owe the entire outstanding balance on that mortgage — even if your lender gets some relief from the PMI.
Your lender can require you to carry PMI, but mortgage protection life insurance is always optional.
Mortgage protection insurance death benefit
As with any life insurance policy, the main benefit on your mortgage protection insurance is paid when you die. Your mortgage lender normally receives that payment directly, and the benefit amount never exceeds the outstanding balance on your home loan. That means your MPI death benefit gradually declines over time as you pay down the mortgage.
Mortgage protection insurance term
The term on your mortgage protection insurance often matches your mortgage term, though some insurers might deviate from the mortgage term based on your age. If you are older than 45, you might be limited to a 15-year term on your mortgage protection insurance even if you have 30 years left on the mortgage. That’s not necessarily a bad thing, either. Fifteen years into a 30-year home loan, you’ve paid off 30% to 50% of the balance. At that point, the benefit of your MPI will decline fairly quickly since you are paying down higher percentages of principal in the second half of the loan term.
Mortgage protection insurance vs. life insurance
Thus far, you’re probably thinking that mortgage protection insurance sounds a lot like regular, old life insurance. And you’d be right; there are similarities. Both pay out the benefit when you die, for example. But the next logical question is, what is the difference between mortgage protection and life insurance? For one, the benefits on an MPI policy are paid directly to your mortgage lender, while a term life or permanent life policy would pay the death benefit to your chosen beneficiary. Also, the benefits available under an MPI policy decrease over time as you pay down your home loan. Most term life and permanent life insurance policies have fixed death benefits.
Mortgage protection insurance also doesn’t accumulate cash value as a permanent life policy would. The cash value component of permanent life insurance generally gives you access to benefits while you are living, in the form of cash withdrawals or policy loans. As noted above, some MPI policies do provide temporary benefits not predicated on your death. These may involve covering your mortgage payment temporarily if you are disabled or unemployed, or giving you access to part of the death benefit if you are diagnosed with a terminal illness.
The table below recaps the main similarities and differences between mortgage protection insurance, term life insurance, and permanent life insurance.
|MPI||Term Life||Permanent Life|
|Living Benefit||Depends on Policy||No||Yes|
|Beneficiary||Your Lender||Whoever You Designate||Whoever You Designate|
|Term||Fixed, Ends When Mortgage is Paid Off||Fixed, Often Renewable||Lifelong|
The application process may also be different between mortgage protection insurance, term life, and permanent life. MPI normally does not require you to submit to a medical exam, while the most affordable term life and permanent life policies would require an exam as part of your application.
Note that because MPI is provided without an exam, it falls into a category of life insurance called “guaranteed issue” or “no exam” coverage. Generally speaking, guaranteed issue life insurance is more expensive than any type of life insurance that would involve a medical exam during the application process. That holds true for MPI as well. You can expect an MPI policy to have higher premiums than a standard term life policy with a similar death benefit.
Advantages of mortgage protection insurance
Initiating mortgage protection insurance does ensure that your family doesn’t get stuck with your mortgage debt if something happens to you. There are other ways to accomplish that goal, but the advantage of MPI is that you can qualify for the coverage even if you wouldn’t qualify for a traditional term life policy. That’s where MPI shines — providing a death benefit that will pay off your largest debt when you can’t obtain other forms of life insurance.
MPI isn’t the only form of guaranteed life insurance available, but the others either have a waiting period or very small death benefits. A common waiting period is two years after policy initiation; if you die during the waiting period, the death benefit is not paid.
Disadvantages of mortgage protection insurance
Relative to other types of life insurance, mortgage protection life insurance has two big disadvantages. First, the premiums may be higher than other forms of insurance. And second, the benefit is very rigid.
Mortgage life insurance cost: higher than other life insurance types
As noted, MPI premiums are generally higher than what you’d pay for a term life policy with a similar death benefit. If you are in good health, you can usually obtain an affordable term life policy that would be enough to pay off your mortgage and possibly other bills too. The advantage of that strategy is that as you pay down the mortgage, it frees up more of the death benefit for your beneficiary to use for other purposes.
Mortgage life insurance benefit: less flexible than other life insurance types
The death benefit on your MPI insurance is paid directly to your mortgage lender. Not only that, but the amount will never be more than your outstanding loan balance. That’s helpful for your surviving family members, because they’re off the hook for the mortgage debt. But it may not be the best use of the funds or the right way to provide for your family. It’s possible your loved ones don’t want to stay in the home after you’re gone, for example, either because the home is too expensive to maintain or because they want to make a fresh start. Paying off the mortgage directly does increase the proceeds they’ll receive if they sell the property later, but it also reduces your loved ones’ liquidity until that sale is closed.
If you had a traditional life insurance policy instead, the death benefit is paid to the person you select as your beneficiary. That individual can then choose how to spend the funds — he or she might pay off the mortgage or address other bills instead, for example.
Who needs mortgage protection insurance?
Mortgage protection life insurance is right for you when all of the following statements are true:
- The best way to provide for your family is to arrange for an automatic mortgage payoff upon your death.
- You can afford the premium payments.
- You’ve applied for other types of life insurance and were either quoted higher premiums or were declined outright.
MPI is a fairly specific type of life insurance and it isn’t right for everyone. Even so, it could be right for you. Take the extra steps to get quotes on other forms of life insurance so you can compare both costs and benefits.
It’s also wise to consult with an estate attorney to ensure that the home can easily pass to your heirs without any hitches. Some states can require a home be sold to pay off other debts left by the estate. That works against you if your goal is to allow your family to stay in the home after you’re gone, and it may sway your opinion on MPI as well.