In the past, it was a legal requirement to have some form of insurance in order for you to qualify for a mortgage. This law was changed because it could lead to a conflict of interest, given that the lender might also profit from selling you the insurance.
The short answer to the question of whether you need insurance in order to take out a mortgage is technically no, but this doesn’t mean that you shouldn’t take a policy out. Although it’s no longer a legal requirement, it’s still a good idea to take out insurance that will cover your financial responsibilities should unforeseen circumstances arise that prevent you from being able to pay them.
Mortgage payments can be a significant amount of your take-home pay. Therefore, if you find yourself unable to keep up with the payments you can end up in serious trouble, or in the worse cases, losing your house. Taking out a policy that protects you from redundancy, illness, or death will mean that your payments are protected. This is especially vital if you have dependents (people relying on you to make these payments such as a partner or children).
Mortgage Payment Protection Insurance
We’ve outlined what mortgage payment protection insurance is before, as well as why you may not need it. Mortgage Payment Protection Insurance (MPPI) is just one of the insurance products out there that provides payment protection if you’re unable to make regular payments.
It’s important to specify that Payment Protection Insurance (PPI) is a different form of insurance to MPPI. Furthermore, you shouldn’t be put off from getting some form of MPPI because of the bad press that PPI has received. PPI has been widely mis-sold over the last 20 years. However, it’s not an intrinsically flawed product and does have some excellent security benefits when properly applied.
In this article, the IMC team outline which aspects of MPPI are most important, as well as other insurance policies that you may consider acquiring before getting a mortgage.
Accident and Illness insurance
If you’re unable to work due to an accident or illness – which, we might add, is never a planned event – having some form of mortgage protection insurance is very useful. If you’re the sole or largest contributor for your mortgage, it’s crucial to consider getting some sort of cover. On top of the various stresses that an illness can entail, the last thing you want to worry about is whether you will be able to stay in your home. For this reason, MPPI is strongly recommended.
Many policies, especially those limited just to illness or accident, can work out to be around 2-5% of your monthly take-home pay, dependent on your health profile and job role. While this may seem like a lot on paper, it will mean that you won’t be left financially vulnerable if you find yourself unable to work. Seen within the wider context of your household spending, it’s excellent value for money. What’s more, this percentage figure is likely to be considerably lower than that of your mortgage payments.
Critical Illness Insurance
Critical Illness Insurance is important if you’re the sole or primary breadwinner and your partner will not be able to make up the difference in payments if you become so ill that you can’t work anymore. These policies usually pay a lump sum if you’re diagnosed with a specific critical illness, which is listed on your policy. These include relatively common conditions such as cancer, heart disease, stroke, as well as some lesser known conditions such as MND or CJD.
Note that these policies will only pay out if you are diagnosed with one of these critical illnesses. Mental illnesses, for example, are very rarely covered by this type of insurance. Also, any family history of these diseases can have a large impact on your premiums. In some cases, it might even preclude you from getting coverage in the first place.
Long-term sick pay offered through critical illness insurance provides a fixed sum on a monthly basis that’s equivalent to most of your in-work pay. It will not fully cover your salary, but it is a tax-free source of income and you are also entitled to state benefits which are not means-tested. It takes the form of a generically worded policy that includes problems as broad and diverse as back pain to mental health issues and is designed to provide coverage for as long as you are unable to work. MPPI is distinguished from long-term sick pay coverage as it only tends to last 12 months.
Life Insurance
Life insurance will be important if you have any dependents who will need providing for if you die unexpectedly or prematurely. Like all insurance, there are lots of variables that are taken into account in order to calculate your insurance premium and payments. Underwriters use a lot of data to calculate the potential risk of each borrower. Characteristics such as age or sex are taken into account as long as they can show, using statistics, that you’re likely to be more expensive to insure or, put differently, you’re a higher risk for them.
Some life insurance policies will pay out a lump sum while others will take the form of continuous payments until they’re deemed no longer necessary. You’re free to use these payments to pay off the mortgage.
Returning to the question of whether you need insurance in order to take out a mortgage, it’s not essential to have life insurance but it could lower your rates when it comes to getting a mortgage. The mortgage lender can be more confident that you’re financially stable enough to make long term payments (to your life insurance policy) as well as knowing that your payments will be covered, should the worst happen.
Caveats
Read the terms of your policy carefully. A lot of accident and life insurance policies come with conditions that mean you aren’t covered in certain specified circumstances. Examples vary between policies and providers but you may not be covered on accidents which occurred while partaking in extreme sports, and suicide or death caused by taking part in a war or act of terrorism are widely not covered. Similarly, where life insurance is concerned, if you died as a result of taking part in a criminal enterprise then you will also invalidate the policy.
Another factor to be mindful of is any pre-existing conditions as these you may limit the type of cover you can get. You may even be refused a policy if your condition is deemed to be too high risk. This is where it’s also really important that you don’t withhold information from your insurer because doing so could shoot you (or rather your dependents) in the foot when the worst happens. There’s little use in paying for a life insurance policy for a year, only for it to invalid when it’s actually needed.
How does this affect a mortgage?
There are two main types of mortgages that people take out. They each have their own benefits, as we’ve discussed elsewhere and they also require different types of protection under insurance.
Under a repayment mortgage, the borrower pays interest and some of the sum of the loan each month. The size of the amount owed decreases until it is fully paid off. This is most suited to a type of insurance called ‘decreasing-term insurance’. Here, while the premiums are fixed, on average the cost is lower due to the fact that the amount of equity that it has to cover reduces over time. If you take out a mortgage of £200,000 for 25 years and after 15 years you have paid off £100,000, then the total amount of coverage you need in order to be able to pay off your mortgage is smaller. It is, therefore, unnecessary for you to be covered for twice the price of your outstanding loan, and the premium you pay to get full coverage will reflect this. This is generally a cheaper way to make sure that you are covered.
The second type of mortgage that people get is an ‘interest only’ mortgage. Here the borrower is only required to pay off the interest each month on the outstanding loan, but at a fixed date they must pay off the total sum. This is often done by selling the property, or when a pension fund matures. This requires a ‘level-term insurance’ which protects the full amount that you are required to pay off up-until the contractually agreed date.
Mortgage insurance is a complex business with many different types available. Seeking out independent financial advice from a broker is the best way to make sure that you are getting the coverage that you require. Lots of policies have caveats that can lead to you not receiving the payments that you expect or your dependents. While these are usually standard, there are many complexities that can be difficult to work out.
While purchasing any form of insurance isn’t entirely necessary before getting a mortgage, there are some policies which carry huge benefits. For professional, unbiased help in choosing a policy that’s right for you, get in touch with the friendly IMC team today.