When I got my first credit card, the bank offered me balance insurance on it.
If something bad were to happen, the balance insurance would cover the full balance of my credit card.
I turned it down, because I knew I didn’t need it. I don’t carry a balance month to month, and my credit limit was a whopping $2,000.
But even though I knew I didn’t need it, I still felt a twinge of guilt. Like, wouldn’t getting the insurance be the Most Responsible Thing?
That guilt was for not insuring a financial product lending me $2,000, maximum.
So today, I want to talk about how to not get guilted into signing up for sub-par insurance product on a much, much bigger loan: your mortgage.
Specifically, and in the interest of full clarity on this, here’s what we’re talking about today.
You probably do not need mortgage insurance, and you probably should not buy it
(If that’s all you need to know, and you accept that, I guess you can stop reading! Just don’t buy it. But I’ve got more details too.)
We’ve talked about a lot of the angles of mortgages over the past year, because it’s by far the biggest financial product most of us are ever going to use in our lives.
- Here’s how to budget for buying a home, and all the other costs to consider.
- Here’s what you should know before buying a home.
- Here’s how to handle the rising insurance rates before you get locked into a mortgage, and calculators to help out.
Your mortgage is likely the second most expensive thing you’ll ever buy, after your house. Consider that at even the historically-low current qualification rate, you’d pay hundreds of thousands in interest on a hundreds of thousands in price house.
So. Yes, it is expensive.
Since mortgages are unquestionably A Very Big Deal, it’s easy to think that insuring them is a good thing, and to feel overwhelmingly guilty when you’re sitting in the bank, telling your mortgage broker or salesperson that no, you won’t be needing the mortgage insurance, thanks very much.
I know, because even knowing what I know now, I had a twinge. Just a small one! But yeah, it’s a weird moment, even when you’re prepared for it.
The only real way to avoid acting on the guilt? Understand what makes mortgage insurance a bad choice, and know what you’re going to do to mitigate the risk instead.
Mortgage insurance is a bad product for most people
Here’s how the mortgage insurance that you add to a mortgage works.
You pay a flat-rate premium every year that you have your mortgage. If you die, the mortgage is paid off.
Great, right? When you’re signing up for $300,000 (or more) of debt, having that all handled for a flat fee is awesome.
But the fee stays the same, even as your mortgage balance goes down. In ten years, when that $300,000 is $200,000, you’re paying the same amount for insurance, even though the hard work of paying off your mortgage means the total benefit amount went down by $100,000.
That’s why it’s not a good product for most people.
Here’s how to mitigate the risk instead
The instinct behind buying mortgage insurance—wanting to make sure the mortgage is handled if you die—is a good one, and very responsible of you, especially if you’re buying a home with someone else and you’d need your combined income to manage it.
You definitely want to mitigate the risk of one of the contributors not being able to earn income because they’ve died, just like you want to mitigate the risk of losing your job by setting up an emergency fund.
But there’s a better way to do it, and it’s called term life insurance.
When you sign up, you agree to a flat fee, for a set number of years, and it will pay out if you die. So if you were to get hit by a bus while you still had that mortgage, your beneficiaries—the people you trust not to secretly murder you to collect your life insurance—would get a set amount of money.
The big difference is that it will pay out a set amount of money. The amount doesn’t go down as you pay off your mortgage.
You’re paying a fixed fee, and the amount your loved ones would get in the worst case situation is also fixed.
See? Way better than paying a fixed fee for a declining benefit.
Buy term life insurance, not mortgage insurance.
If you want an accessible, easy-to-read guide to the things you need to know when buying life insurance (and also many other key personal finance things) I genuinely have not found a more helpful and readable guide than the insurance section in Stop Overthinking Your Money, by Preet Banerjee. It’s what gave me the confidence to buy our term life insurance, and know that I was getting the right product, underwritten the right way. You should read it.
Why is it only bad for most people?
There’s one thing that trips up this example, because if there was One True Answer, this wouldn’t be personal finance.
If you can’t get life insurance, because of a pre-existing condition or something along those lines, speak with an insurance broker to see what your options are to mitigate the risk of carrying a big mortgage. There’s a wide world of insurance products out there, and a broker can help you navigate them.
And hey, they might recommend that yes, you spring for the mortgage insurance, because it’s the combo of the lowest cost and most relevant benefit for you. Just because it’s a bad product for most people doesn’t mean it isn’t the right fit for some people.
But if you can get term life insurance? Mortgage insurance is not the best product to mitigate the risk of carrying that much debt.
Now that we’ve got that cleared up, you can stop thinking about death and start thinking about the fun parts of home buying, wheeeeeeee!