Before you accept the responsibilities of taking on a mortgage that spans several decades, there’s an option you might consider to protect the home from foreclosure in case you’re not able to make the monthly mortgage payments.
Mortgage protection insurance (MPI) 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 the borrower dies.
MPI can be a safety net for some homeowners while others may view it as an unnecessary expense 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?
MPI policies basically function as a type of life or disability 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 up to a year or two. The policy will spell out if there is a mandatory waiting period before payments are made. These 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 may not be a financially prudent move. Instead, homeowners should use the DIME (debt, income, mortgage, education) method, which 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.”
The difference between MPI and PMI
MPI can easily be confused with another mortgage-related abbreviation for private mortgage insurance–PMI, or private mortgage insurance. The names and abbreviations of both of these insurance products are almost identical, but they are distinctly different.
Unlike MPI, which protects you, private mortgage insurance protects the lender from financial losses when you fail to repay your loan. PMI is required 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 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.
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 because of injury, illness or death.
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. So the total potential payouts from these policies gradually shrink over time. However, some of the newer MPI policies include what’s known as a level-death benefit, a feature meaning that total potential payouts don’t decline.
As MPI is paid directly to your lender, it won’t provide financial protection to your loved ones if you die–except insofar as it will pay off the mortgage. 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. Term life for this purpose offers more flexibility, as proceeds are paid to beneficiaries, not to mortgage lenders. And premiums for term life are generally lower than those for MPI for non-smokers in good health.
Also, MPI prices vary considerably, and it can be hard for consumers to get price quotes online, compared with other types of insurance.
As with any type of insurance, the key is to compare the premiums and benefits of MPI policies against other types of insurance that would serve the same purpose–in light of your particular situation and goals. Though term life might be a better option for some individuals, others might want it specifically because it pays off the mortgage directly, rather than paying proceeds to beneficiaries. For example, this would protect relatives living in the home in the event that the beneficiaries of an insurance policy (if they are different parties) choose not to pay off the mortgage.
Choosing an MPI provider
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.
