We occasionally help homeowners looking for decreasing term mortgage protection policies. These policies were popular before the 2008 housing and economic crisis. Decreasing term life insurance policies were convenient and easy to apply for during the financing process; convenience was their major selling point.
While you were completing your home loan paperwork to purchase your home, you were offered the opportunity to purchase a decreasing benefit term life insurance policy. We did this on one of our homes in the past, and it was very convenient!
What we didn’t know at the time was there were better options available to us. There were options that would offer us more protection, more flexibility, and would be in place long after the mortgage was paid off or refinanced.
But before we go any further into this, let’s cover life insurance basics. We will also go into some details about what we consider ideal mortgage protection policies versus straight life insurance.
Mortgage protection policies typically include benefits unavailable on straight life insurance products, options such as the return of premium, critical illness availability, terminal illness, confined care riders, and a simplified non-medical application process.
By not having to have a physical examination, have your blood tested, have your urine tested, and have an intensive medical background check, we can get more people mortgage protection policies than with fully underwritten life insurance policies.
So how do we protect homes and incomes with our clients? Our first preference is through nonmedical simplified issue mortgage protection products.
If our clients don’t need the benefits provided by these nonmedical life insurance policies, we will look at full medical, fully underwritten life insurance products.
One of our core operating principles is: “We will always recommend products that benefit our clients before benefiting us.” This means, if we have to take a lower compensation on a product to do the right thing for client, we will…every time!
Term life insurance
The simplest form of life insurance available is called term insurance. It gets its name because it is often purchased for a set period (in years), after which it is no longer renewable.
Term life insurance is known for being the most affordable life insurance product available to purchase. The pricing is very attractive, considering all other life insurance alternatives. There are three basic types of term life insurance policies:
Annually (Yearly) renewable term life insurance
Annually renewable term (ART), or yearly renewable term (YRT), is priced differently each year the policy is in force. These policies are guaranteed renewable up to certain ages. ART’s are typically issued between 10 and 30 years’ length of time, with a maximum age of 75 to 80 years old (depending on the insurance company).
The monthly or yearly premium cost follows a schedule clearly stipulated by the insurance company upon issue. You can clearly see what your insurance premiums will be as you get older.
As the insured person gets older each year, the YRT gets more expensive each year. This is because the probability of you dying increases every year.
In the early years, the price increases are often negligible (when you are in your 20’s or 30’s years of age). As you age, however, your probability of dying increases at an exponential rate, and your ART pricing increases accordingly. Once you enter your 50’s, your formerly cheap term life insurance policy will start getting more expensive!
These life insurance policies are designed in such a way that, when you need the coverage the most (when you are older), they effectively price you out of coverage. There’s nothing wrong with these policies. Just understand the way they work and know that, in your later years of life, you will likely not have the life insurance protection you need because of insurance premium price increases.
Level term life insurance
Level term life insurance addressed some problems with the ART’s and YRT’s. Consistency in payments that fit into your budget over the years is the primary advantage of level term life insurance. Wouldn’t it be nice to know that, in 20 years, your $39 per month life insurance premium would be the same as today?
An ART could have a $39 life insurance premium, right now, and a $457 per month in 20 years. This example should show you why level term life insurance is so attractive.
Instead of a gradually increasing life insurance premium (like with a YRT), a level term life insurance policy has a fixed premium for 10, 15, 20, or 30 years. Some insurance companies will offer 5 or 25-year terms, but these policy periods are less common. The price savings between 5 to 10 years and 25-30 years are often minimal.
The concept behind the level term life insurance is that the insurance company charges you a premium more expensive in the earlier years than a YRT. The insurance company then charges you a less expensive premium than it would’ve charged you in the later years of a YRT.
Often, these term insurance policies are not renewable at the end of the term. Some insurance companies, however, allow you to continue your coverage up to age 95. If you had a 30-year term policy, at the end of the 30 years, the insurance company would recalculate your insurance premiums at your current age (now 30 years older than when you purchased your policy).
This often makes these products unaffordable after the term period has ended. A $1,200 a year premium could increase to a $12,000-$18,000 a year premium after the 30-year period.
Shorter periods of time are less expensive to insure than longer periods of time. A 10-year level term will be less expensive than a 20-year level term. A 20-year level term will be less expensive than a 30-year term. This is because of the following reasons:
- With a shorter guaranteed coverage time (10 years versus 20 years), the insurance company can raise your rate sooner (example – upon renewal of a new 10-year contract). They will charge less, because they’re insuring you for a shorter length of time; they have less financial exposure over a ten-year period than a 20-year period.
- Insurance companies know your insurance habits. They know that, when a 10-year level term life insurance policy ends (or lapses), you are likely to purchase a new policy. The shorter the term period, the shorter the time the insurance company will be responsible for paying out a death benefit.
Decreasing term insurance
Decreasing term insurance (or reducing term insurance) is used primarily to cover certain financial obligations when someone dies. This used to be offered as mortgage protection insurance and was sold by mortgage companies as they processed your loan documents.
If you signed for $100,000 mortgage to purchase a house, the reducing term insurance benefit would start at $100,000 and decrease over time as you made your mortgage payments. When you owed $85,000 on your home, insurance coverage would only pay $85,000.
The $85,000 would be paid to your bank, not a designated beneficiary. So, although your home would be paid off, these policies were less flexible than other life insurance products available.
This is why a level term mortgage protection policy or level term life insurance policy is the preferred way to protect your home mortgage.
The final problem with this insurance is it was sold under a group plan through the mortgage companies. These were not individual plans owned by the homeowner.
When the homeowner sold their home or refinanced their home, this decreasing term insurance attached to the mortgage was automatically canceled.If your health changed, you became ill, or had a terminal illness since your last home purchase, you wouldn’t be able to qualify for this insurance on your next home purchase.
After the housing market crash in 2008, the mortgage companies virtually stopped selling this insurance with home loans. It is not a readily available option for homeowners today.
No term life insurance policies accumulate cash value. That is why the premiums are so affordable. Term life insurance is very much like automobile insurance. You pay a little money monthly (monthly premium) to transfer a larger financial risk to an insurance company (your death benefit payout).
Term life insurance is the same way. You pay $120 a month for a $500,000 life insurance policy, and if you die within the term of your life insurance policy, the insurance company will pay your beneficiaries $500,000, but you never get your premiums back (unless you have a return of premium plan rider in place).
Term life insurance is the most affordable way to purchase mortgage protection or life insurance for a specified period. If your mortgage or life insurance needs would be longer (up to age 100 or 120) then a different life insurance product would be more appropriate.