A home is almost always going to be the most expensive purchase any of us will ever make. The cost is so high that, usually, we do it in partnership with our spouse or other loved one and, for all but a very few, housing prices today require two working incomes to pay the mortgage and all the other bills. When you make the commitment to buy a house or condo, you should also purchase the peace of mind that a life insurance policy provides so that your partner (and family) are protected in the event of the untimely death of a breadwinner.
But, what are the best options for needing life coverage for their mortgages? And how much coverage do you need? There's no one-size-fits-all answer, but there are some do's and don'ts to abide. Here's what you should know.
Decline the Bank’s Offer
First thing’s first: do not buy mortgage insurance from your bank. When you sign your mortgage documents your banker or broker will ask if you’d like to have mortgage insurance. Say no. The main reason is that the bank is the real beneficiary of a mortgage insurance policy. Instead of getting a tax-free lump sum that you’d get with a private life insurance policy – leaving your survivor(s) free to determine how to best spend it – the payout of a mortgage insurance policy goes directly to the bank. Mortgage insurance policies also decline in actual value as you pay down the principal of your mortgage, where a term or permanent policy (more on the differences between the two in a moment) maintains a fixed value for the duration of the plan.
Here’s a more detailed explanation about why you don’t want the bank’s mortgage insurance policy.
Term Life Insurance Policies
Let’s face it, death is inevitable. The variable is how soon the grim reaper will come for you, making life insurance something of a gamble. It comes down to choosing between a “term” policy or a permanent one. Term policies, as the name suggests, last for a specific term, or period of time. The terms are usually for 10-, 20-, or 30-years. The tax-free “death benefit” payout is set up front, based on your age, health, and amount of monthly premium you’re willing the pay. The premium stays the same for the length of the plan. If you die before the expiry of the plan, your beneficiary will receive the full amount. If you live beyond the length of the term, the policy expires and you get nothing for your years of paying into it. The advantage, however, is that term policies are significantly cheaper than permanent plans, typically cited as being about one-fifth the cost of a permanent plan.
Permanent Life Insurance Policies
There are two types of “permanent” insurance: whole life or universal life plans. The key difference is that with whole plans you have a fixed premium, while with universal plans you can raise or lower the premium you choose to pay (within a set range) over the life of the policy.
Both provide coverage for as long as you live (though that’s typically capped at 100 years, maybe less depending on the provider). There’s also an investment component to a permanent policy that you can cash out if you need immediate funds, though doing so reduces the value of the death benefit payment.
It's also possible to convert a term insurance policy to a whole-life policy, generally before you turn 75.
Who to Insure?
Assuming there are two co-signers on the mortgage, you may wonder: should both have equal amounts of insurance coverage? The answer to that is, it depends.
If one partner earns significantly more than the other does, it might make sense to have a higher payout on the higher earner. But someone with a well-paying job may also have an employee insurance plan that would provide coverage above and beyond whatever private policy you opt for. So the two variables may cancel each other out.
Situations may also change. One partner may choose to stay at home for a period of time while their children are young, effectively giving them no income. Back once the children reach a certain age, that person could go back to the workforce and have a thriving career.
In the case of my wife and I, when we bought our first house, we both purchased 30-year term policies that would cover the bulk of our mortgage at the time we signed the documents. At the time, we were both in our early 30s and healthy, so the premiums on a term policy were fairly low. (We’re both still healthy, but not in our 30s anymore!) We opted to pay a bit more for a 30-year term so that it would take us into our 60s. Our reasoning was that by the time we approach retirement, if both of us are still alive we should have paid off most, if not all, of our mortgage. With our other investments (RRSPs, RESPs, and a rental income property), we felt that by that stage in life, we will be financially sound enough to provide enough for each other and our two children who will be themselves around 30 by that time.
The Disability Debate
One other factor to consider are disability riders on life insurance policies. There are a number of different options on the market (from coverage for medical equipment to private nursing), but the key component is one that provides income in the event that a policy holder is severely injured and is unable to work.