Do I need life insurance for a mortgage? How does it work?

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  • You don’t have to buy life insurance when you get a mortgage, but it’s a sensible thing to think about when making a major financial commitment, like buying a home.

    No one can be sure what the future holds, and life insurance means you know your mortgage payments will be covered if you’re not around. “Nobody likes to think about death, but you should think about how your dependents would cope if you were to die,” says David Hollingworth of L&C mortgage adviser.

    Do I need life insurance for a mortgage?

    No, lenders will not insist that you purchase life insurance to obtain a mortgage. Lenders expect to be able to recover the money they lent you through the sale of the house if necessary, so life insurance is not about protecting them. Rather, it is about protecting those closest to you, who depend on your financial support. Still, many lenders will urge you to get life coverage at the same time you get a mortgage, and it’s generally wise to protect your loved ones in the event of your death.

    Think about how a long-term partner, spouse, or children would handle payments if you weren’t around. “If you have children, it’s particularly important to consider how they’ll be taken care of financially should something happen to them,” says Jonathan Harris, director of independent adviser Harwell Protection Group.

    Even if you have a partner who works and earns a good salary, you cannot be complacent. In the event of his death, could they still earn this way? Particularly if you have children. Life insurance can be invaluable in this situation.

    Likewise, if you live alone, you will have less of a need for life insurance along with a mortgage. If you die before paying the mortgage, your mortgage becomes a debt against your estate and must be paid before the money passes to the beneficiaries.

    terraced house facade

    Image Credit: Futre PLC/ Colin Poole

    How does life insurance work?

    There are several different types of life insurance to choose from. For example, ‘level term insurance’ gives you the same amount of coverage for the term of the policy and can be used in conjunction with a mortgage. You may decide that you want a policy to last for 20 years, for example, with a payment that covers both your mortgage and other expenses.

    However, mortgages are generally taken on a repayment basis these days. So you pay the interest and part of the originally borrowed amount every month, and your mortgage balance goes down over time. ‘Decreasing term insurance’ is designed to work in conjunction with a mortgage, with payments falling each year, and you set the policy payment and term to match your mortgage. This is usually a cheaper form of life insurance.

    Ideally, take out life insurance as soon as possible. Insurers take your age and health into account when setting your premium, and younger people generally pay less than older policyholders. You’ll pay around £18 a month for £150,000 in level term life insurance. For example, at ages 35-45, increasing to more than £30 at age 50.

    The most expensive type of life insurance is “whole life insurance.” As the name suggests, this covers you for your lifetime (as long as you keep paying premiums). So beyond the term of the mortgage.

    What insurance is a legal requirement when contracting a mortgage?

    The only insurance that is legally required when taking out a mortgage is building insurance to cover the cost of repairing damage to the structure of the property. This will be stipulated in the terms of the mortgage.

    Still, don’t obsess over what’s required. Chris Sykes of broker Private Finance says: “We always recommend that clients also take out other forms of protection such as life insurance, income protection and critical illness cover when applying for a mortgage.” Income protection insurance, for example, will make sure your family has a regular income or a lump sum if you can’t work after a serious illness, so the bills get paid.

    Harris says, “With more people now surviving serious illness and living with the impact of the condition, needing home modifications and often ongoing private medical treatment, making sure you have coverage is more essential than ever.”

    It is a good idea to seek independent financial advice before choosing the cheapest life, critical or income protection insurance policy. It’s critical that the policy is right for you and that it pays when your family needs it most. Adds Harris: ‘Consult an independent adviser with access to all insurers in the protection market to get the right advice and policy for you. This will ensure you get comprehensive coverage, as not all insurance products or claims handling are the same.’

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