Mortgage protection: What is it? Why should you have it?
You have a mortgage; finances are tight because you have stretched yourself so much just to get a foot on the housing ladder. Then you get sick and cannot work for the next 2 years. What happens to your mortgage? Is your new home now at risk of being taken away?
You are renting; You’ve tried the property ladder, but right now it is out of reach. Your family relies on your income to keep paying the rent. Then you have an accident and cannot work for the next 5 years while you rehabilitate. What happens to your family’s home? Is it now at risk of being taken away?
These two examples are basic, but they help to illustrate the majority of reasons why people get this type of personal insurance. Below is a list of nine things you should know before you talk with your financial adviser.
- The purpose of disability products
- Home mortgage – not investment
- “I don’t have a mortgage” (then, use your income)
- “Offsets’’ not applied
- 4 core cost components
- Add-ons and additional benefits
- Premium type: YRT / Level
- Partial Payment Benefits
- Common Claims
1. The purpose of disability products
Mortgage protection insurance, is in a suite of products that you might hear referred to as income replacement, or disability insurance products. They will pay the benefit to the effected person on a monthly basis, until that person goes back to work, or the benefit period ends.
Generally, it is “Agreed Value”. This means that the amount insured, also known as the ‘benefit amount’, is agreed at the time of application. There are other income protection products that will determine the benefit amount at claim time.
If you are unable to work due to injury or illness, the benefit will start paying you, after the “waiting period”.
Typically, people may have a mix of both mortgage repayment insurance and income protection. This is because both works slightly differently, although they compliment each other very well.
2. Home mortgage – not investment
You can insure up to 115% of home mortgage repayments. Why 115%? Interest rates can fluctuate – so this amount gives you a buffer. Not all insurers will go to 115%, but most will do 110%-115%. However, they will require proof, like a bank statement.
The insurance can only be on your home mortgage, not on your investment property. Your tenants will continue to pay you rent, even if you have the accident. Therefore, with this product, you are not protecting that financial risk.
3. “I don’t have a mortgage” (then, use up to 45% of income)
Many providers will allow you to use 40-45% of your gross income, instead. Not everyone has a mortgage. This means that you can use the benefit, should you need to, towards paying your rent. You will need to provide the insurer proof of your income.
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4. “Offsets’’ not applied
Unlike many income protection products, mortgage repayment benefits will not be ‘offset’ by other income sources. This means that you can still receive your mortgage repayment insurance (MRI) and the other income.
In New Zealand, many people think of ACC is this context. If you have an injury, you may get some ACC assistance, and, the benefit paid by your insurer.
This type of cover is not normally classed as taxable income. Again, unlike many income protection products, which are taxed as income, typically, MRI isn’t.
5. 4 core cost components
As with the other products in the income replacement suite, there are four main points of price:
- The amount you are insuring
- The waiting period – the longer the wait, the cheaper the premium
- The benefit term – the shorter the benefit is paid, the cheaper the premium
- Occupation Class
The waiting periods from most providers are 4 weeks, 8, 13, 26 and 52 weeks. For example, you might choose a longer waiting period if you have some income protection already in place. It depends on the risk protection strategy that you are working on with your financial adviser.
The benefit periods are typically 2 years, 5 years and through to age 65. Some insurance companies will go beyond age 65, which is becoming more relevant as people are working longer than the historical retirement age.
The type of occupation that you do will also determine the price. Some jobs are just riskier than others. Unfortunately, some roles are not covered at all. Each provider has their own definitions and criteria.
6. Add-ons and additional benefits
Another seven articles could be written on this point alone! There is a lot of variety among the insurance providers in the add-ons and ‘extras’ that they offer. They all try to find their own niche in the market, and this is one area that they can deviate from the competition.
Effectively, the insurance firms offer product enhancements, of which some are built-in, the others are optional (paid) extras.
You might come across things like:
- Funeral (or bereavement) benefit
- Permanent disability benefit
- Recurrent disablement
- Rehabilitation and support
- Childcare support benefit
- Mental health discounts
- Inflation protection
The range is wide and list is long.
7. Premium type: YRT / Level
As with many personal insurance products, you can elect two ways to pay.
The first is yearly renewable term (YRT). This is effectively saying that your contract is yearly, with the price re-setting each year. It will increase, because you get older, there will be inflation, and the cost of the product will change.
The second option is ‘levelled’ premiums. Here the contract is over ten or more years and you pay the same amount each year. However, yes, you have price certainty but the premium in the early years is higher than you would pay on YRT. The upside though can be significant. As you progress through your contract, the amount you pay will seem less and less compared to the YRT premium. In many cases you could potentially save thousands of dollars over the life of the policy.
Level vs YRT = price certainty & high long-term savings vs lower initial cost and a potentially costly product over time.
8. Partial Payment Benefits
Many insurers will offer partial payment benefits. This might be for a specific injury or a listed critical illness. It does depend on the provider, and you will need to be aware of the fine print.
Often these benefits will be paid in addition to the monthly-paying benefit that you receive.
For example, a fractured wrist may not mean that you need two years off work, but it will cause you some financial difficulties if you are a tradie or a surgeon. The specific injury benefit might be handy here.
9. Common Claims
The different companies have slightly varying statistics on their claims. However, for the disability products like mortgage and income protection, the top claims are as follows:
- Muscular and joints (including back issues and accidents)
- Mental illness/ workplace stress
- Neurological conditions and stroke
Asteron Life, who is one of the major providers has it illustrated as this
While it may appear that mortgage repayment insurance is a minefield with different options, much of what I’ve discussed is quite straight forward. In saying that, choosing a financial adviser to walk you through the product is a smart move. Let the professional help you navigate the right options that suit you and your situation.