The Truth About Mortgage Life Insurance

Are you building wealth through real estate? If so, you probably understand the value of using OPM (Other People's Money), such as a bank's, to help make your fortune. This, of course, means that you are using debt, but good debt, to purchase appreciating and income-producing assets. However, many banks and other financial institutions require that you own or purchase enough life insurance to cover the loan amount in the event you die before the loan is paid back.

Although your lender may tell you the owning a life insurance policy that names the bank as beneficiary is a prerequisite to obtaining a loan, in most cases you don't have to purchase the policy offered by the lender. Any life insurance policy can be "collaterally assigned" to the lender to satisfy their requirement. Why not purchase the policy through the lender? Because typically what is offered is a mortgage life insurance policy, which is nothing more than over-priced decreasing term life insurance. There is a better way, but let's first understand what mortgage life insurance is and why it's not recommended.

Mortgage Life Insurance

The idea behind a mortgage life insurance policy (also known as mortgage protection insurance) is simple enough: You pay a fixed premium for the duration of the policy and, if you should die during that time, the insurance company pays off the amount remaining on your loan to the lender. In other words, the "death benefit" is equal to your outstanding loan balance and is continually decreasing as you pay down your loan balance. Therefore, you are paying the same premium each month for less and less insurance.

The problem with mortgage life insurance is the high cost of the insurance compared to the risk. It is estimated that mortgage insurance companies actually pay out less than 30 cents in claims for every dollar they collect in premiums. A typical mortgage life policy covering a $100,000, 30-year mortgage for a 40-year old non-tobacco user costs about $40 to $50 per month. In comparison, a 30-year guaranteed term life insurance policy costs approximately one-half that much and the death benefit remains level instead of decreasing. Obviously, term life insurance is a much better buy than mortgage life insurance.

Increase Your Cash Flow

Reducing your insurance costs is one way to have more positive cash flow on your properties.

Strategy: Use term life insurance either for continuing mortgage payments or for paying off a mortgage.

Use term life insurance to replace the income of the deceased. The beneficiary simply invests the life insurance proceeds and continues making the usual monthly payments from the resulting income. Another great strategy is to own enough life insurance to pay off your mortgage(s) if you die. You want your family to be relieved of mortgage payments if you are not around. Don't confuse PMI insurance with a policy that will protect your family.

Don't pay the high cost of mortgage life insurance when you can accomplish the same thing with an inexpensive term life insurance policy

"PMI insurance does nothing to protect your family."

Don't Confuse PMI With Mortgage Life Insurance

Private Mortgage Insurance (PMI) is often mistaken for mortgage life insurance, however, it is a totally different product. PMI is nothing more than a promise of a private insurer to repay your lender in the event you default on your loan. Most lenders require that you purchase PMI insurance if you have put less than 20% down on your mortgage.

Even though you pay the premiums, your PMI agreement is actually a contract between your lender and the insurance company. If you default on your loan due to death, loss of job, or any other reason, the lender can collect 20 to 25 percent of the total outstanding loan from the PMI insurer, and foreclose on the property.

Or, the PMI insurance company could pay off the entire loan and thus gain title to your property. Either way, your family is not protected.

On the other hand, in the event of your death, a term life insurance policy, not PMI, would provide the cash needed to prevent default on the loan and loss of the home to your family. Read your loan contract carefully and confirm the time or situation when the PMI can be dropped. 

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