THE PITFALLS OF MORTGAGE LIFE INSURANCE

When you're gambling, the “house” expects to win. They’re on the lookout to make sure you don’t have insider information that puts the odds in your favour.

Term life insurance is a form of gambling. The products are sold at the younger ages where death is unlikely. Rates increase sharply with age and coverage is not available near life expectancy where payout is most likely. Insurers also underwrite each applicant individually, medically and financially. You’re required to disclose insider information. If you're a smoker or otherwise unhealthy, you pay more or get rejected.

If you’re honest, healthy and financially sound, you’ll likely get insured. More important, your claim is very likely to be paid. You have peace of mind. That’s not true for mortgage life insurance from your lender.

Uncertainty

The mortgage life insurance your bank offers you works differently. Buying insurance makes sense since you wouldn't want your family to lose their home if you pass away. You might sense pressure to buy coverage from the bank. That’s called tied selling and is illegal. Yet you’re vulnerable. If you refuse, will your mortgage be approved at a preferred rate?

If you buy, you're getting what is called creditor insurance. The bank is the creditor which means you're the debtor. Creditors worry about protecting themselves, not you. They also make nice profits from this type of insurance.

Since there are so many mortgages and so few claims, underwriting you at the time you buy is expensive. Why not underwrite you at the time of the claim? That makes financial sense to the creditor but what about you? You don't know if you're insured until the exact point the money is needed.

Did you notice the inconsistency?

The bank does extensive financial underwriting for your mortgage because they're concerned you might default (and inconvenience them). They don't bother to do insurance underwriting because that would cost them now and the risk of claims is low. Put differently, they're more worried that you'll default than die. Do you have the same priorities?

Consequences

The perils of buying mortgage life insurance from the lender are well known. Here are seven articles for background:

1. Mortgage insurance not always a sure thing (CBC Marketplace video, Feb 2008)
2. Mortgage insurance vs life insurance (Canadian Capitalist, April 2009)
3. Perils of a mortgage life policy (Toronto Star, April 2007) + addendum (Ellen Roseman)
4. Don't buy insurance from banks (Ellen Roseman, April 2009)
5. Post-claims underwriting (Money Smart blog)
6. Why am I denied insurance coverage? (Thicken My Wallet, May 2009)
7. Why I won’t sell mortgage insurance (Dave The Mortgage Planner)

Protect Yourself

You protect yourself by buying your own insurance elsewhere for flexibility. You then decide where the proceeds go. You'll probably want to cover debts like your mortgage and leave money for your family to replace the income you provided. You'll likely save money too.

Insurance advisors range in quality. You won't get true peace of mind unless you take the time to select an advisor you can trust. That’s key to getting your claim paid.

There's one weak reason to buy mortgage life insurance. If your claim looks reasonable but is getting denied, the media may help. The bank may then make a business decision to pay to avoid bad publicity.

Post-claim underwriting is not consumer accountable but is still with us. Buyer beware.

Links

• Tips for first-time home buyers (new)
• Two types of insurance you may have but can never own  (new)
• Three keys to getting your claim paid
• What happens during a paramedical exam for life insurance
• The effect of banks selling you insurance online
• Three steps to keeping financially solvent
• How the wealthy feel about their advisors
• image courtesy of Svilen Milev (Bulgaria)

Podcast 127 (4:50)

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PS Before ditching your mortgage life insurance, be sure you have a replacement securely in place.