Protecting the family home
Let’s face it, for the vast majority of us, a mortgage is likely to be the single largest debt that we will incur in our lifetime.
Whether you’re a first-time buyer or a couple approaching retirement and looking to downsize, protecting your home is vital so not to financially burden your loved ones.
But what is the best way of protecting your mortgage?
Well, you have 2 main options; decreasing term or level term life insurance.
But which one to choose? What are the ‘pros’ and ‘cons’ of each policy?
Let us guide you through the facts, so you can make an informed decision that meets YOUR unique needs.
Why life insurance?
Firstly, let’s deal with why we might need life insurance.
If you or your partner was no longer around, could you:
- Afford the monthly mortgage repayments?
- What about on-going household bills (gas, electricity, water, council tax)?
- Maintain your current standard of living?
- Would you have to downsize?
- Would you need to return to work in order to pay the bills?
- Who would look after the children if you had to return to work?
- Could you afford expensive childcare costs?
Life insurance could help provide answers to all these difficult questions. Providing your loved ones with much needed financial security.
Decreasing vs level term cover
Let’s look at the characteristics of decreasing and level term life cover.
A decreasing term life insurance policy is the most common and cost-effective way of covering your mortgage debt.
It’s designed to help protect a repayment mortgage. The amount of cover (AKA the size of the pay out) reduces over time in line with your mortgage balance.
This means your beneficiaries would receive enough to pay off the balance of the mortgage, however, there would not be much money left over.
With level term life insurance, the level of cover remains the same throughout your policy.
If you die at any point during the term, your beneficiaries would receive a fixed lump sum, regardless of whether that is right at the start or the end of the policy.
Both decreasing and level options are term-based policies. This means cover lasts for a set period of time, and the policy has a defined start and end date.
Therefore, your loved ones can only benefit from the policy if you die during the term.
The term length
When protecting the family home it makes sense for your life insurance to align with your mortgage term.
This ensures your family home is always protected.
If your mortgage term was 30 years, then your life insurance policy should be at least 30 years too. Simple.
However, if you have other reasons for having life cover, like meeting the future living costs for children or to leave an inheritance, you may want the cover to exceed your mortgage term.
Do you have children or other dependants?
Whether you have children and/or dependants is highly likely to impact the type of life insurance you take out.
If you don’t have any dependants and only need your life insurance to cover the mortgage, then decreasing term cover may provide sufficient coverage.
However, if you’re a parent and wish to leave an additional lump sum, as well as cover the mortgage, then level term may better suit your needs.
Remember, if you have a repayment mortgage and level term cover, the further into the policy you live and the more of your mortgage you pay off, the greater the leftover sum will be.
Assuming you do not outlive your policy.
Repayment mortgage vs interest-only mortgage
If you have bought your home by taking out a repayment mortgage, either decreasing term or level term could meet your needs and cover the debt.
However, if you have an interest-only mortgage, where the capital borrowed does not decrease over time, then decreasing term would not be suitable.
The cost of your monthly premiums
As a general rule, level term premiums, which provide a greater level of protection, are approximately 20% dearer than decreasing term.
With decreasing term cover the financial risk to the insurer reduces over time, which helps keep monthly premiums lower, compared with level term.
However, it’s important to remember there are many other factors which impact premium costs, such as your age, health, weight (BMI) and whether you smoke.
Guaranteed vs reviewable premiums?
Whichever policy type you decide on, you have the choice of reviewable or guaranteed premiums.
But what’s the difference?
Guaranteed premiums are great if you like certainly, as the amount you pay each month remains the same throughout the policy.
If you decide on a reviewable premium, it’s likely to be slightly cheaper than a guaranteed premium to start with.
However, the insurer has the option to increase the monthly premium cost at intervals during the term. This may become unaffordable in later years.
Joint cover or 2 single policies?
Regardless of whether you decide on decreasing or level term cover, you have the choice of taking out a joint policy or 2 single policies.
Again, this is a very personal choice and will depend on your individual circumstances and budget.
However, there are some important considerations to factor into your decision making.
On a positive note, the cost of a joint policy is generally cheaper than taking out 2 single policies. However, the saving is usually small.
You could take out a joint policy, which would cover your mortgage if one of you was no longer around. However, it will only pay out once, usually on the first death.
Whereas, if you had 2 single policies you could benefit from 2 pay outs and effectively double the level of cover. This could be a major factor if you have children to consider too.
Whatsmore, if you have joint cover and a claim is made that policy would expire, leaving the remaining partner to take out a new policy, when older (thus more expensive).
Do you have protection through your employer?
If you have some protection through your employer, like death in service, this is likely to influence the cover you take out.
For example, if you have 4x your annual salary paid out by your employer, then decreasing term cover may be sufficient.
Or it might be that you still require greater coverage than just covering the mortgage, however, employee benefit could impact the amount of level term cover you require.
Regardless of your individual circumstances, cover via your employer is a definite consideration you should factor into your sums.
It’s worth mentioning that it can be a good idea (and is perfectly legal) to take out more than one policy to cover different aspects of your life.
Additional critical illness protection?
Most life insurance policies now come with terminal illness cover as standard.
Meaning if you suffer a major illness covered by your policy, which is likely to result in your death within 12 months, your insurer will pay out early.
There is also the option of adding a critical illness element to a decreasing or level term policy.
This would most likely cover you against conditions like a stroke, heart attack, Parkinson’s disease, MS, Alzheimer’s disease and more.
However, this additional protection is likely to increase the cost of your monthly premium.
Also, check which conditions are covered by your policy, as not all cover is the same.
Getting access to a pay out early and not having to worry about money could be a massive benefit to you and your family at a very difficult time.
Write your life insurance in trust (minimise 40% IHT)
Minimise 40% inheritance tax (above the £325,000 threshold) and speed up the pay out by writing your life insurance policy in trust.
You can do this with either decreasing or level term cover.
Writing your policy in trust means your policy avoids forming part of your legal estate and you assign the rights of the policy over to a nominated trustee/s.
Reassured offer a free trust service, and we can help with the application process if required.
Is life insurance compulsory if you take out a mortgage?
Mortgage life insurance, whether that be via decreasing or level term cover, although a very good idea, is not usually compulsory.
However, some mortgage lenders may request that you have life cover in place before agreeing to release funds, ensuring their risk is protected.
DON’T automatically buy life insurance through your mortgage lender
From our experience, many homeowners are encouraged to take out cover either through their lender or via their lender’s preferred insurer.
Normally, you can secure a much better deal if you compare multiple quotes yourself or use a broker.
Even if you have taken out a policy and now think you could have secured a better deal elsewhere, you can always replace it and get a new one.
This could make you a significant saving in the long-term.
There is no definitive right or wrong way to protect your family and your home.
It’s a case of finding the right cover to protect your specific needs, meet your available budget and match your circumstances.
The best way of securing the right policy at the best price is to shop around and compare multiple quotes.
You could do this yourself, or you could save yourself time and money by getting a broker to do it for you.