When taking out a new mortgage, it is often a time to review your insurance policies and determine if they fit your needs. Often our customers will consider if they need life insurance when they are either taking out their first mortgage, or moving to a new property. The answer will always depend on your specific circumstances and acceptable level of risk, but this guide is available to help you decide.
What is life insurance?
A life insurance policy will pay your dependents, such as your partner and/or children, either a lump sum or regular payments if you die. It is an insurance policy specifically to enable you to provide for your dependents if you were no longer alive to provide for various costs of living.
How much is paid out upon your death depends entirely on the level of cover you purchase. You can organise a life insurance policy to cover specific payments, such as a mortgage. There are two kinds of life insurance to choose from:
- Whole of life policies will pay out whenever you die, as long as you have kept up to date with the premiums
- Term assurance policies will pay out if you die during the fixed term of your policy, typically 5, 10 or 25 years
Who needs life insurance?
Life insurance is useful to provide reassurance that your dependents will be supported should the worst happen. When considering who needs life insurance, first consider who would be affected if you passed away.
If you are single with no dependants or partner it may well be that you don’t need life insurance to cover your mortgage. If you die before the end of your mortgage term, your property can be sold to repay the mortgage as no one else would need to live there. If, however, you have dependants or a partner it is almost certain that you should have life insurance to cover the mortgage debt.
If you are single, perhaps you should not be thinking about the financial consequences of dying, instead you should ask yourself what would I do if I cannot work due to accident or illness? This question applies equally as well to those of us with partners and dependants.
If you have life insurance to pay off your mortgage, what about the loss of income your partner and dependants will suffer if you die? Although they won’t need to pay the mortgage any more, they will still suffer the loss of the rest of your income with the same, if not greater, expenditure going forward.
Three questions to ask yourself when considering life insurance:
- Do I need to ensure that my debt is cleared on my death without the need to sell assets such as my home?
- Will my dependants and partner need to replace some of my income if I die?
- If I become ill or have an accident that stops me working, will I be able to meet my normal expenditure until I return to work?
The solution to the problem posed by the first question is fairly straightforward. If you die and have outstanding debts, these need to be settled by your estate’s executors. This will normally mean the mortgage (and any other debt) being paid off by either the sale of your home or by your partner taking on the debt alone.
A simple and, usually, cost effective solution is to take out a life insurance policy (joint life if you have a partner) that will pay off the debt in full if you die, leaving the home for the benefit of your surviving partner and dependants with no mortgage.
If, as is the norm today, you have a repayment mortgage with a reducing balance each time you make a monthly mortgage repayment, it is possible to start a policy that has a level of cover that reduces in line with the mortgage debt.
This type of policy is known as decreasing or reducing term assurance. If properly set up, it will guarantee to repay the mortgage debt in full if you (or your partner) die before the end of the mortgage term, providing you make all the mortgage payments when they are due. A decreasing term assurance policy is also normally the lowest cost method of protecting your mortgage against your (or your partner’s) death.
Do I need life insurance if I have employee benefits?
If you have a mortgage but no personal life insurance cover, have you considered what would happen financially if you died with the debt outstanding? Would your employee benefits deal with this need?
Many of us are unsure of exactly what cover is provided by an employer for both death in service or being unable to work due to accident or illness. Sadly, many people find there is a gap when they find themselves needing to use these employer benefits.
The cover is not guaranteed to remain the same. Employers are always looking for ways to reduce costs and, sometimes, this can result in a change in benefits that may not be immediately obvious. The point here is that the cover is not in your control.
If you change employers, the benefits at your new position may not be the same. This can be a busy, and not ideal, time to review your family cover. Further, if your health changes in the future, you may not be able to arrange the cover you would ideally want.
In my opinion, usually, these types of benefits should be used to replace income for the family unit if you are unfortunate enough to die or become ill whilst working, the very reason this type of cover came about in the first place.
Insuring more than the mortgage payments
I have observed that a lot of people feel comfortable making sure the mortgage is paid off but do not consider whether there is any need for additional life insurance.
If you have dependants and the family unit loses the income you provide, even though the mortgage is paid off there is still the same expenditure as before. It may even increase. You should ask yourself and your partner:
- How much of my income would you need to replace if I died and the mortgage was paid off?
- Can the surviving partner exist on their income alone?
- Will the surviving partner want to spend more time with your dependants or arrange for appropriate care whilst they remain in full time work?
If you work out the income shortfall and length of time it is required, you can identify how much it will cost to protect. It is often a lower cost than many imagine.
When considering how much insurance you need, it is important to consider all eventualities. Ask yourself:
- If I am unable to work as a result of accident or illness, how long will I get paid by my employer?
- When that payment stops, what happens next? Will state benefits be enough for me and my family to maintain our home?
- What happens if I become ill and want time to recover and reorganise my lifestyle but do not get time to do so?
If, like most, you haven’t properly considered these questions I would urge you to do so now. We are all aware of the recent reforms to our state benefits regime. If you need to rely on state benefits, almost certainly you will deem them insufficient.
If you are off work due to accident or illness you will be paid by your employer for a period, but for how long? 1 month? 3 months? A few employers will go to 6 months. Even less will have longer term arrangements.
It is possible to arrange cover that will start when your employer’s cover ceases to replace your income. The cover will remain in place until you return to work or reach retirement, whichever occurs first.
You could, however, suffer an illness that does not keep you off work for long but could leave you wanting to change the way you work. You might want a less stressful role, part time work or a gap to recover fully. Examples could be heart attack, cancer or a stroke and are commonly referred to as critical illnesses.
How much critical illness cover should you have?
Again, the answer to that question will vary with each individual. However, a common solution is to cover the amount of your mortgage debt. Should you be unfortunate enough to be diagnosed as having suffered a critical illness, your mortgage will be paid off and your home secure. This should remove stress and allow you to change your work and lifestyle to maximise your chances of as full a recovery as possible.
In the previous two decades, critical illness cover gained a reputation for not meeting claims. Often, this was because the application process itself had not been properly followed. Recent changes in regulatory supervision and law have made this type of cover much safer today, providing you are properly advised by a professional firm.
Get help finding the right life insurance cover
VA Mortgages expert advisors can help you prioritise and maximise the cover you need from the budget you have available.
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