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.
Further Reading
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!
Stupid question… but where do you get term life insurance ? 🙁
Not at all a stupid question! Usually you’d work with an insurance broker to get it, and I believe banks also sell it, but before I did that I compared rates on LowestRates.ca, and that really helped me understand what a ballpark price was for the coverage I wanted. Preet’s book, Stop Overthinking Your Money, was the best handbook I could have had for the process!!
Is this mortgage insurance you’re talking about different than “private mortgage insurance” (PMI)? It’s my understanding that if you do not have 20% for a down payment you are required by the lender to purchase PMI. And you can get rid of it once you have 20% equity. Maybe this is just a US thing? Thanks!
Hi Alle! Yes, this is different than PMI. Here in Canada, we call the equivalent CMHC, and the main difference is that the mortgage insurance I’m talking about protects YOU in the worst case, and PMI/CMHC protects the bank if you default on your loan 🙂 Should have been more clear about that in the post!
Hi Desirae,
Some good points and here are a few more to consider:
1-Everyone has different circumstances so work with CFP to determine your needs
2-If you die and the bank pays out the mortgage, you may be hit with penalties from paying off and closing the mortgage early! This has happened.
3-To be fair, Some banks do offer critical illness and disability coverage on their mortgage insurance products, and if you are a smoker and in otherwise good health, the mortgage insurance would probably be less for a good length of the mortgage term even with its declining coverage. Having said that, speak with a CFP who is also an insurance broker to compare products and prices that would suit your circumstances. Many Life insurers offer critical illness add-ons for minimal extra costs.
4-In most cases you answer very simple qualifying questions for the bank’s insurance product. Answer any of them wrong and no payment. Underwriting is done after you die for the bank mortgage insurance. With your own policy, all underwriting is done before the policy is issued. As long as you answered all questions truthfully, the beneficiary receives the death benefit. One question that used to be on the bank’s application was whether you had been tested for low or high blood pressure. Most people answer no as we don’t have low or high blood pressure but the answer is yes for everyone because we are tested each time we have a annual physical and our doctor IS testing for high or low blood pressure. This has happened and a claim was denied. see http://www.cbc.ca/marketplace/episodes/2008-episodes/in-denial
5-If you change mortgage companies, you will have to apply for new insurance. If you obtain your own policy, it is yours to be used as your beneficiary sees fit to use and you can bring it with you if you change lenders.
6-See #1!
Hey Mark, AWESOME additions, thank you! Totally right that a CFP can also help determine what the best insurance strategy is for your particular needs, I heartily second that! And that was the biggest takeaway from Preet’s book for me as it relates to insurance – you want it underwritten when you get the policy, not when you die. It seems like more work, but that one piece of advice was so key in helping us navigate the life insurance process! I gave some pretty strong side eye to all offers of “no underwriting required!” life insurance policies, and we ended up doing supplementary medical for one of us based on our history. All good, and so happy to have done that now, instead of being denied a claim later.
This must be a Canadian thing, right? I’ve never heard of insurance like that in the States. Mortgage Insurance (MI — or PMI, Private Mortgage Insurance, which is the same thing) refers to something a bit different over here, I believe. PMI in the States is more about protecting your lender, and is not optional if you put less than 20% down. 🙁
Totally! This type of insurance is different than PMI (we call it CMHC here in Canada!) and it does aim to protect you, not the lender – at least that’s the sales pitch 😂 Ours is really similar in that it’s not optional for under 20% down payments! I paid it on our mortgage, haha, but then we got life insurance instead of the bank-offered mortgage insurance.
Life insurance is way cheaper than Mortgage insurance too! Sadly we only put down 10% on our mortgage so we’re stuck with PMI for two years now matter what. PMI = $516/yr and my life insurance = $156/yr. On top of that my life insurance covers twice the value of my home! Life insurance is definitely the way to go!
Amazing! And honestly, exactly the same here – we did 10% down and although the programs are structured differently here in Canada, had to pay CMHC, which is our equivalent of PMI!