Mortgage Protection Life Insurance is designed to repay the outstanding balance of a repayment mortgage in the event of death (or earlier critical illness).
A repayment mortgage is a mortgage loan where each month the interest due and some capital are repaid.
During the early years relatively little of the loan is repaid each month with larger amounts repaid later in the term.
The Mortgage Protection Life Insurance (and/or Critical Illness) premiums are determined at outset and are usually guaranteed for the term of the policy. Reviewable premium plans are available, but again these are not widely sold. The graph below shows how the sum assured falls over the policy term in the same way that the amount of capital outstanding on a repayment mortgage falls over time.
Not all mortgage protection life insurance and critical illness insurance plans pay the same amount on claim. This is because the different insurance companies use different ways to work out how the life cover should fall over the term. There are basically two ways that are in common use.
The first method……is to assume a fixed mortgage interest rate, typically 10%, and reduce the amount of life insurance and critical illness cover in line with this assumption. This means that irrespective of the mortgage amount outstanding, the life insurance and/or critical illness insurance payable at claim will be that which would have been payable assuming the mortgage had been run at an interest rate of 10%.
You can see from the graph below that the amount payable during the life insurance term increases with interest rate. A policy that assumes an interest rate of 10%, pays more than a policy that assumes an interest rate of 5%, half way through the plan term.
Also it is worth noting that the life insurance or critical illness insurance payout is not linked to the mortgage and may therefore payout more than the outstanding balance if average interest rates have been lower than the assumed interest rate of 10%, or less if interest rates had been higher than the assumed rate. Furthermore the life insurance cover or critical illness insurance cover will be paid irrespective of whether there is a mortgage outstanding or not.
The second method……is to guarantee the repayment of the outstanding balance of the mortgage, irrespective of interest rate. This method offers guarantees but is usually subject to certain criteria. These can include, ensuring that the mortgage protection plan is set up for at least the amount of the mortgage outstanding in the first place, and over the same term. Furthermore mortgage payments must be up to date at the date of claim, which could be more of a problem if the claimant has been unable to work for a period due to ill health and has become behind with mortgage payments just before death. Under these circumstances if there is no mortgage in place when a claim is made then the policy usually works as per method one above but might assume quite a low interest rate (typically 5%) to work out the sum payable.
