What type of policy is right for me?
Most lenders require, or at least recommend, that borrowers protect themselves with life cover that ensures the outstanding mortgage amount will be repaid on the premature death of the borrowers.
In some cases, although rare these days, lenders also insist on taking an "assignment" on the life policy - in other words become the legal owner of the policy which they then hold in their files. In the event of the death of a policyholder, the insurer will pay the proceeds to the owner - in this case, the lender - to discharge their liability under the policy. If there is a surplus, then the lender would return the balance to the policyholder's estate.
There are principally two types of mortgage:
A Capital & Interest "Repayment" Mortgage
In this case, as the capital repayable is slowly reducing over the mortgage term in order that the balance owed reaches zero on the last day of the mortgage, it is sensible to have life cover whose sum assured payable on death is designed to reduce at a similar rate. Such plans are known as "Decreasing Term Assurance" or "Mortgage Protection Plans". Because the life cover is designed to reduce over the term in line with the mortgage balance, the cost of this cover is the lowest of the plans on the market.
An Interest Only Mortgage
With an Interest Only mortgage the amount outstanding remains at the initial mortgage amount throughout the term of the mortgage, with the total sum repayable in one go on the last day of the mortgage. This obviously means that any life cover used should remain constant throughout the term to provide the protection needed.
In the case of an Endowment linked mortgage, the endowment contract is a combined investment and life assurance plan within a single policy, where the minimum payable upon death before the end of the term is guaranteed to be the initial mortgage amount. As the investment part of the plan increases in value, the life assurance element reduces, as it only has to pay out the difference between the investment element's value and the guaranteed death benefit payable.
In the case of all the other Interest Only mortgages, it is normally appropriate to protect the loan with a Level Term Assurance, whose sum assured on death remains constant throughout the term at the initial amount of the mortgage.
If the loan is a "lifetime loan" - in other words, is designed to continue for an open ended term - common in latter years where an interest only loan may be set up with no predetermined term and the loan ultimately repayable upon death - then it is more appropriate for the loan to be covered using a Whole of Life Plan. Such plans are, as the name suggests, set up to continue until a death occurs before paying out the sum assured. Because of the structure of these plans, there is an investment element involved, and it is wise to seek professional Independent Advice before purchasing such a contract.
One or Two Borrowers
If a mortgage is set up with two borrowers, then it is often desirable to have a plan where the death benefit would be payable if either party to the mortgage dies before the end of the term. Whilst one can have two separate policies, one on each person individually, this tends to be a more expensive option.
In such situations therefore it is normal for the life cover to be taken out on a joint life basis, with the death benefit payable on the death of the first of the two parties to the mortgage and then cease completely, it's purpose having been satisfied (leaving the survivor with no further cover). Such Plans are known as Joint Life/First Death versions. This version is normally available on all types of life cover, including Endowments, Mortgage Protection Plans, Level Term Plans, and Whole of Life Plans.
Diagnosis of Critical/Serious Illnesses
Nowadays, most people are concerned that they could suffer a serious illness, such as a heart attack, stroke, or cancer, etc., and that, whilst they may well overcome the condition and live a long and happy life, this could result in a change of lifestyle and consequentially an often reduced income. In order to protect oneself from that event, it is normally possible to incorporate a benefit within any of the life plans described above known as Critical Illness cover.
Critical Illness cover is designed to effectively "pretend" that the policyholder has died upon medical diagnosis of one of a range of serious illnesses, including those described above, effectively meaning that the mortgage could be fully repaid in the event of such a condition being diagnosed.
Critical Illness cover is available as an option within the life plans as a "first event" payment - in other words, the death benefit will only payout once, on the first event of either a critical illness diagnosis or death, and the plan then ceases having done it's job.
The option can be incorporated within a Joint Life Plan which effectively becomes a Joint Life/First Event contract, where the sum assured pays out on death or diagnosis of a critical illness of either policyholder, whichever occurs first, and then ceases (leaving the surviving party with no further cover, and, if it was a critical illness claim, the claimant with no further life cover).
In some cases, although rare these days, lenders also insist on taking an "assignment" on the life policy - in other words become the legal owner of the policy which they then hold in their files. In the event of the death of a policyholder, the insurer will pay the proceeds to the owner - in this case, the lender - to discharge their liability under the policy. If there is a surplus, then the lender would return the balance to the policyholder's estate.
Types of Mortgage
There are principally two types of mortgage:
- A Capital and Interest or "REPAYMENT" mortgage
- An Interest Only mortgage.
- "Pure" Interest Only - No specified repayment vehicle (usually appropriate when a borrower has a number of investments which will be ultimately used for the capital repayment)
- Interest Only linked to:
- An endowment policy (which incorporates life cover automatically)
- An ISA plus term assurance
- A pension scheme or plan plus term assurance
A Capital & Interest "Repayment" Mortgage
In this case, as the capital repayable is slowly reducing over the mortgage term in order that the balance owed reaches zero on the last day of the mortgage, it is sensible to have life cover whose sum assured payable on death is designed to reduce at a similar rate. Such plans are known as "Decreasing Term Assurance" or "Mortgage Protection Plans". Because the life cover is designed to reduce over the term in line with the mortgage balance, the cost of this cover is the lowest of the plans on the market.An Interest Only Mortgage
With an Interest Only mortgage the amount outstanding remains at the initial mortgage amount throughout the term of the mortgage, with the total sum repayable in one go on the last day of the mortgage. This obviously means that any life cover used should remain constant throughout the term to provide the protection needed.In the case of an Endowment linked mortgage, the endowment contract is a combined investment and life assurance plan within a single policy, where the minimum payable upon death before the end of the term is guaranteed to be the initial mortgage amount. As the investment part of the plan increases in value, the life assurance element reduces, as it only has to pay out the difference between the investment element's value and the guaranteed death benefit payable.
In the case of all the other Interest Only mortgages, it is normally appropriate to protect the loan with a Level Term Assurance, whose sum assured on death remains constant throughout the term at the initial amount of the mortgage.
If the loan is a "lifetime loan" - in other words, is designed to continue for an open ended term - common in latter years where an interest only loan may be set up with no predetermined term and the loan ultimately repayable upon death - then it is more appropriate for the loan to be covered using a Whole of Life Plan. Such plans are, as the name suggests, set up to continue until a death occurs before paying out the sum assured. Because of the structure of these plans, there is an investment element involved, and it is wise to seek professional Independent Advice before purchasing such a contract.
One or Two Borrowers
If a mortgage is set up with two borrowers, then it is often desirable to have a plan where the death benefit would be payable if either party to the mortgage dies before the end of the term. Whilst one can have two separate policies, one on each person individually, this tends to be a more expensive option.In such situations therefore it is normal for the life cover to be taken out on a joint life basis, with the death benefit payable on the death of the first of the two parties to the mortgage and then cease completely, it's purpose having been satisfied (leaving the survivor with no further cover). Such Plans are known as Joint Life/First Death versions. This version is normally available on all types of life cover, including Endowments, Mortgage Protection Plans, Level Term Plans, and Whole of Life Plans.
Diagnosis of Critical/Serious Illnesses
Nowadays, most people are concerned that they could suffer a serious illness, such as a heart attack, stroke, or cancer, etc., and that, whilst they may well overcome the condition and live a long and happy life, this could result in a change of lifestyle and consequentially an often reduced income. In order to protect oneself from that event, it is normally possible to incorporate a benefit within any of the life plans described above known as Critical Illness cover.Critical Illness cover is designed to effectively "pretend" that the policyholder has died upon medical diagnosis of one of a range of serious illnesses, including those described above, effectively meaning that the mortgage could be fully repaid in the event of such a condition being diagnosed.
Critical Illness cover is available as an option within the life plans as a "first event" payment - in other words, the death benefit will only payout once, on the first event of either a critical illness diagnosis or death, and the plan then ceases having done it's job.
The option can be incorporated within a Joint Life Plan which effectively becomes a Joint Life/First Event contract, where the sum assured pays out on death or diagnosis of a critical illness of either policyholder, whichever occurs first, and then ceases (leaving the surviving party with no further cover, and, if it was a critical illness claim, the claimant with no further life cover).