ELLEN CHANG MAY 28, 2019 in MORTGAGES
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Before you accept the responsibilities of taking on a mortgage that spans several decades, there is an option to protect your future loan payments in case you can’t make them.
Mortgage protection insurance protects homeowners if a health issue arises and they become disabled, or a job loss is lengthy. In the worst-case scenario, this type of coverage can pay off the balance of the mortgage if you die.
Mortgage protection insurance can be a safety net for some homeowners while others may view it as an unnecessary bill that will drain an already tight budget. Deciding whether to purchase a mortgage insurance policy depends mostly on your health and financial circumstances.
What is mortgage protection insurance?
Mortgage protection insurance, or MPI, is another kind of life insurance. The cost of the monthly premium varies, depending on the amount of the loan and the individual’s age and health. Some MPI policies cover a mortgage if there is a disability, and those premiums depend on the borrower’s occupation.
If you die with a mortgage balance and have mortgage protection insurance policy, your insurer pays the remainder of your loan balance directly to the lender. Any heirs, such as a spouse or children, won’t have to worry about making future mortgage payments or losing the home.
MPI policies that pay a benefit for a job loss or a disability typically cover your mortgage payments for a year or two. The policy will spell out if there is a mandatory waiting period before payments are made. These MPI policies generally cover the principal and interest portion of a mortgage payment and not other fees like homeowners association dues, property taxes or homeowners insurance. You may be able to add a contract rider, though, to cover these expenses.
Mortgage protection insurance is not required for loan approval, says Bruce McClary, vice president of communications for the National Foundation for Credit Counseling.
“It will come at an additional cost that is added to the monthly loan payment,” McClary says.
A mortgage protection insurance policy is typically not a financially prudent move. Instead, homeowners should use the DIME (D-Debt, I-Income, M-Mortgage, E-Education) method that factors in the amount of a mortgage in choosing how much term life insurance you should purchase, says Henry Yoshida, CFP, CEO of Rocket Dollar, an Austin, Texas-based self-directed IRA and solo 401(k) provider.
The DIME method is a way to calculate how much life insurance coverage you need. To do this, you add up all of your outstanding debt, your income, outstanding mortgage balance and anticipated education expenses of your children, according to the World Financial Group. Then subtract from that sum any existing insurance coverage you have in place. If there’s a surplus, you have enough coverage but if there’s a shortfall, that’s the amount of term life insurance you should purchase.
“This method completely negates the need to get mortgage-specific insurance,” Yoshida says. “(Meanwhile), people should simultaneously practice better overall financial planning tactics.”
The difference between MPI and PMI
MPI can easily be confused with another mortgage-related acronym for private mortgage insurance, or PMI.
Unlike MPI, which protects you, private mortgage insurance protects the lender from financial losses when you fail to repay your loan. PMI is required when you don’t have at least a 20 percent down payment of the loan amount.
Paying PMI helps many first-time homebuyers qualify for a mortgage when they don’t have a lot of cash saved up for a down payment. Once you’ve paid down your loan balance or your home value has increased to reach 20 percent equity, you can ask your lender to remove PMI from the mortgage. Lenders are required to terminate PMI automatically once your loan balance falls below 78 percent of the home’s original value.
The average annual PMI premium typically ranges from .55 percent to 2.25 percent of the original loan amount per year, according to data from Genworth Mortgage Insurance, Ginnie Mae and the Urban Institute.
Pros of MPI
One benefit of mortgage protection insurance is that it’s typically issued on a “guaranteed acceptance” basis so the likelihood of getting approved for a policy is high. That could be advantageous for people who have health issues and either have to pay high rates for life insurance or cannot obtain a policy.
If you’re unable to get disability insurance because you work in a high-risk job, MPI could give you the protection you need if you can’t make mortgage payments if you get injured, fall ill or die.
Cons of MPI
If your mortgage is nearly paid off or you paid for the home with the proceeds of the sale of another house, paying for a mortgage protection insurance policy is not a good use of your money. Instead, that money could be stashed away in an emergency fund or retirement portfolio.
If you have taken out a home equity line of credit or a home equity loan, MPI only provides coverage for the initial mortgage amount.
Homeowners who plan to make extra payments to pay off their mortgage early also won’t benefit as much from MPI because the loan payoff amount decreases as the mortgage is paid down.
Remember that MPI is paid directly to your lender and won’t provide financial protection to your loved ones if you die. A term life insurance policy might make more sense because the policy is paid to your beneficiary who can then decide how to allocate the money, whether it’s to the mortgage or to other investments.
Choosing and saving on MPI
You shouldn’t settle on a mortgage lending without shopping around first, and the same is true of MPI providers. Evaluate the pricing and features of MPI policies from a few insurance companies, and make sure you understand what the policy does and doesn’t cover. You can check insurers’ financial health by researching its credit rating from AM Best, a global credit ratings agency for the insurance industry.