What is Mortgage Protection Insurance?
Mortgage Protection Insurance is a term used to encompass various different types of cover designed to protect borrowers from events which could severely impact upon their ability to maintain mortgage payments. There are different variations but when connected to a mortgage they are all there to provide peace of mind and usually fall in to the following categories:
- Life Cover
- Critical Illness Cover
- Income Protection
- Accident, Sickness, Unemployment (ASU) Cover
- Family Income Benefit
Life cover generally falls into two types – “Whole of Life” or “Term Assurance.” Whole of Life cover is guaranteed to pay out a lump sum on death, whenever it occurs. Term Assurance pays out if you die within a specified term of years. There are also different types of term assurance – for example “level,” “increasing” or “convertible” – but the type most commonly used as mortgage protection these days is “Decreasing Term Assurance.” This can be linked to a repayment mortgage and the sum assured reduces at roughly the same rate as the mortgage balance over the specified term. Because the risk to the insurer diminishes over time, the premiums are generally cheaper than the other types of life cover. If the policyholder dies within the term, then the sum assured should be enough to pay off the outstanding mortgage balance and ensure the borrower’s dependants aren’t left with a debt they might not otherwise be able to manage.
Critical Illness Cover
There’s an argument that says that life cover is taken for the benefit of other people – i.e. your dependents – because sadly you won’t be around to see any benefit yourself. However, these days, thanks to improvements in the sort of medical treatment available, many people now survive conditions which once might have been fatal. Nevertheless, whilst undergoing what may be lengthy spells of treatment and recovery, it could have a marked effect on your ability to meet your financial commitments. This has led to the development of Critical Illness cover. This works in a similar way to Life Assurance, in that it is usually taken for a specific term of years and can have the different options such as level/increasing etc. It is designed to pay out a lump sum and, like Life cover, for borrowers it is typically taken on a decreasing term basis in line with the reduction of your mortgage balance. The key is that the benefit is paid if you fall victim to one of a number of specified critical illnesses, and pays out whatever the long term prognosis of that illness. The type of illnesses covered vary from company to company but, in general terms, insurers usually cover between 40 – 50 specified conditions including cancer, heart attack and stroke. Pay-outs depend on meeting the required level of seriousness of the particular condition suffered and the life companies all work to at least the pre-designated clinical definitions as prescribed by the Association of British Insurers. This means that they can’t just arbitrarily decide that you’re not ill enough. Hopefully, if your treatment is successful, it means that not only have you survived, but you can benefit from your prudence by no longer having a mortgage to pay after your illness.
In practice many companies will offer Life and Critical Illness Critical cover as a combined policy and would usually pay out on the “first event” i.e. whatever happens first – either death or serious illness – the pay-out is made. They can also be written on a single or joint life basis
Whereas Life and Critical Illness cover pays out a lump sum, “Income Protection” pays out a monthly sum designed to replace your wages in the event of you being unfit to work. Unlike Critical Illness cover, there are no restrictions on the illnesses or injuries covered, the only factor being whether they make you unfit to work. There are however restrictions in how much you can cover and how quickly benefits would start to be paid. This is largely because the insurers want you to have an incentive to return to work rather than being better off on sick. Typically, the most you can cover would be approximately 55%-65% of your income and benefits would begin to be paid after a “deferred period” which would normally equate to the length of time you would receive sick pay from your employer. Benefits would continue to be paid for as long as you remain unfit to work or until the policy term ends, whichever comes first. However, to make premiums cheaper, most companies offer a “budget” option whereby benefits would be paid for a shorter period – usually between 2-5 years – to at least allow you to make alternative arrangements in case it looks like you’ll be incapacitated for longer than that. Like Life and Critical Illness cover, these policies are underwritten based on your health and lifestyle at the time you apply. All income protection policies are written on a single life basis.
Accident, Sickness, Unemployment (ASU) Cover
Similar in many ways to Income Protection these policies also cover you should you be made unemployed. Benefits are usually linked to your mortgage and other costs (rather than necessarily your wages) and would usually be paid one month “in arrears” after a successful claim. These policies are only underwritten at the time of a claim rather than at the outset, which can sometimes mean there can be some confusion/delay as to whether a claim would actually be met. They are clearly a useful safety net if you are made long term unemployed but be sure to check the details of how/when any unemployment benefits would be paid out, as it may be that you would have returned to work before any monies become due.
Family Income Benefit
Probably the least common of the “mortgage protection” type policies but can often be valuable – particularly for those with young families. These plans can be taken to cover Life and/or Critical Illness and are underwritten on application in the same way as mentioned above. However, unlike the traditional forms of policy, rather than pay out a lump sum, the cover would pay an annual or monthly income for the remainder of the term of the plan. Thus it can replace the income of the main bread winner for a number of years, dependent upon a particular client’s circumstances and, because of this would usually be written on a level or basis, or an index linked basis designed to keep up with inflation.
There’s an old adage that says you can never have too much insurance. Certainly many people have one or more of the different types of policy and it would be wrong to think of Mortgage Protection Insurance as just an “either/or” choice. However, in the real world, affordability plays a massive part, so whilst it would be fantastic to cover yourself for every potential opportunity, a good advisor will sit down with you and tailor the type of cover to be the most suitable combination to your family’s priority and budget. If you do take more than one type of policy however, your advisor would usually place all the cover with one provider. This is to save you the additional policy administration charges which individual policies carry but which are reduced when bringing all the policies under one plan.
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