How mortgage insurance really works

Hey there, time traveller!
This article was published 20/11/2024 (541 days ago), so information in it may no longer be current.

Dear Money Lady,

My husband died in January, and we had paid into mortgage protection insurance from 2004. The issue is that we had been paying mortgage insurance for 19 years with our regular payments and when my husband died, we began a claim for the mortgage insurance and provided all the information to the bank. At that time, we were told there were two possibilities for claim – death or accident. However, because the cause of death was a heart attack they focused on the single death claim. We originally took out the insurance when the mortgage was $482,000 and I was shocked to only receive $231,864, which covered the balance of the mortgage. I thought the death coverage was for the original mortgage amount, but the bank said they had to account for the amortization on the loan. Should I get a lawyer to fight this?

Jane

I am so sorry for your loss, Jane.

Unfortunately, the mortgage insurance you purchase from the banks is very different to what you may be used to with a regular insurance policy. Mortgage insurance is upsold by financial institutions to pay off your mortgage balance in the event of a death and the beneficiary is the bank not the mortgager. These funds are used to pay out and discharge the mortgage balance at the time of death, regardless of the amount that you started with. The cost of this insurance is always based on the original mortgage amount and added onto your monthly mortgage payments to make it more convenient. So, if the balance of your mortgage was only $231,864 and this is what the bank paid – then that would be correct.

Term insurance that you purchase through a licensed insurance agent pays out the face-value of the policy as a lump sum to the beneficiaries in the event of a death. This is very different from mortgage insurance, since the original amount of the policy stays the same. The money paid out from a term-insurance policy can be used any way you wish – to pay off debt or a mortgage, to invest, or to replace lost income.

Most people opt for mortgage insurance when they first get a mortgage since it is very easy to acquire. There is no medical exam and you usually only have to truthfully answer a few questions at the time of application. For all its conveniences, mortgage insurance purchased through your financial institution still has many drawbacks. When your mortgage is paid off, if you move to another lender, or when you sell your home, your coverage ceases.

Term life insurance on the other hand, is much more detailed and may require medical tests and questions to underwrite the policy at the time of application to ensure the policy will be paid out if a claim is made. The costs for this type of insurance varies based on your health, age, the coverage amount, and the term. Yes, it may be more cumbersome to get, but the benefits of a term policy far outweigh the bank’s alternative. Remember your coverage never changes (unlike mortgage insurance, which decreases over time as your mortgage amount gets smaller) and it is portable. Regardless of whether you move, pay off your mortgage, or decide to change your lender, the term policy stays in place and you have peace of mind knowing your family is protected in the event of a tragedy.