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The Do Hard Money team focuses on real estate investing. But, once in a while, we get a good question about homeownership that I like to address. In that vein, someone recently asked me: is it worth getting mortgage protection insurance?
With mortgage protection insurance, you make a monthly insurance premium payment. Then, if you or your spouse die, the policy pays off your remaining mortgage. I recommend against this expense. You can get better financial protection for the same costs by purchasing a term life policy and investing.
I’ll use this article to review some more considerations with mortgage protection insurance. Specifically, I’ll cover each of the following topics:
- What is Mortgage Protection Insurance
- Why I Don’t Recommend Mortgage Protection Insurance
- Alternative 1: Term Life Policy
- Alternative 2: Investing
- Alternative 3: Combination
- Final Thoughts
What is Mortgage Protection Insurance?
Of note, I’m using this article to address homeownership, not investing, topic. Frankly, I’ve never used mortgage protection insurance as an investor, and I don’t even know if insurers offer this protection to investors.
Having said that, I’ll begin with a definition of mortgage protection insurance. If you’ve purchased a home, you likely received dozens of solicitations in the mail shortly after closing. Insurers track public property records, and they mail out mortgage protection insurance solicitations to any new homeowners. But, how does this insurance actually work?
When you purchase a mortgage protection insurance policy, the insurer will pay off the balance of your loan if you or your spouse dies. For instance, assume someone has $150,000 remaining on a mortgage. If he or she dies, the insurer will pay off that entire balance. This means that either A) the other spouse, or B) the homeowner’s estate will receive the home free and clear of a mortgage. If only one spouse receives an income, this protection prevents the other spouse from needing to find a job to pay the mortgage if the other dies.
Insurers structure the payments on this policy similarly to a life insurance policy. Every month, you pay a portion of your annual premium. Over the life of the policy – generally the loan term – you pay the same amount every month to keep the insurance current.
Why I Don’t Recommend Mortgage Protection Insurance
As a homeowner, I’ve never personally used mortgage protection insurance, and I don’t recommend other people get it either. I have two main reasons for believing this product just isn’t worth the expense.
First, your mortgage protection insurance only covers your outstanding mortgage balance. Let’s say you buy a policy to protect a 15-year mortgage and need to pay $50 per month for the premium. You’ll need to pay that same $50 per month from the first year all the way through the last year. However, if you die after paying off half the mortgage, the insurer will only pay out proceeds for the other half. In other words, you pay the same for all 15 years, while the insurer needs to pay less and less each passing year.
Second, you can only use the proceeds from a mortgage protection insurance policy for paying off the protected mortgage. But what if your spouse needs cash for other expenses (e.g. healthcare, college tuition, etc.)? Too bad. This reality significantly limits your financial flexibility.
Mortgage Protection Insurance Alternative 1: Term Life Policy
Rather than limiting their financial flexibility with mortgage protection insurance, homeowners can consider a term life insurance policy. With respect to payments, it’ll look similar to mortgage insurance. You’ll purchase a policy for a certain dollar amount and term. For example, say you purchase a $500,000, 20-year policy. This means that, every month for 20 years, you’ll pay a certain amount of money into the policy. If you die at any time while that policy remains active, the insurer will pay out $500,000 as a death benefit.
This set-up has two key advantages over mortgage protection insurance. First, the payout doesn’t decrease. If you die in the first year or the last year, the insurer will still pay the full $500,000 death benefit (recognizing that inflation will reduce the purchasing power of that payout later in the term).
Second, the beneficiaries of a life insurance policy can use the proceeds for anything – not just to pay off an outstanding mortgage balance. This provides tremendous financial flexibility. When you sign up for a 20-year policy, how can you accurately predict what your loved ones’ financial needs will be 10, 15, or 20 years later? You can’t. Term life insurance policies embrace this uncertainty and provide the flexibility to use funds for any needs. And, if the beneficiaries need to pay off a mortgage, they can certainly use term life insurance benefits to do so.
NOTE: If you decide to purchase a term life insurance policy, do it as early as possible. Premiums are far more affordable the younger and healthier you are, and you lock in those monthly payments for the life of the coverage.
Mortgage Protection Insurance Alternative 2: Investing
Investing serves as another alternative to purchasing mortgage protection insurance. With this approach, you essentially create your own “mortgage insurance.” Rather than purchasing a policy, calculate what you would pay every month if you did purchase one. Then, take that amount, open a brokerage account, and invest the money every month. Over time, those invested funds will continue to grow, providing you money to access in the event of an emergency. And, with a brokerage account, you don’t need to die to use the funds, a key advantage.
However, you should also recognize two drawbacks to this approach. First, if you begin investing and then die in the second year, there likely won’t be enough funds to pay off a mortgage balance. Second, stocks go up on average, over time. In the near term, stock portfolios can face a ton of volatility. This means that, if the market happens to be down when you need to access your brokerage funds, you’ll need to realize a loss.
Mortgage Protection Insurance Alternative 3: Combination
I personally recommend this final approach as an alternative to mortgage protection insurance. Rather than choose between purchasing a term life insurance policy and investing funds into a brokerage account, do both!
When you review your family’s budget, determine an amount that you can comfortably part with every month. For example, let’s say that after all of your expenses, other savings, and general “fun money,” you have $100 per month remaining. Use a portion of that to pay for a term life insurance policy, and set up an auto-investing transfer into a brokerage account with the difference. This gives you the A) protection of a life insurance death benefit, and B) the flexibility of brokerage cash to access at any time.
And, in theory, your income will increase over time. While your life insurance payments will remain the same, you can contribute more and more every month to your brokerage account.
As both a homeowner and real estate investor, I absolutely argue that it is not worth getting mortgage protection insurance. The product limits your financial flexibility while providing diminishing benefits over time. For peace of mind, homeowners are far better served purchasing term life insurance policies and investing excess disposable income in a brokerage account.