With so many different types of life insurance, such as level term insurance and decreasing term insurance, which type of cover is right to protect your mortgage? This guide has been written to help you answer that very question…
With a decreasing life insurance plan the amount of cover declines over time, reaching zero by the end of the policy term. For example, at the start of the plan the level of cover may have been set at £100,000, by the half-way point the amount of cover may have fallen to £70,000 and by the end of the policy life no cover would remain.
The rate at which the amount of cover declines works in accordance with the interest rate assumed on the policy. It is typical for plans to automatically assume an interest rate of between 8 per cent and 10 per cent. As the amount of cover reduces over time the monthly premiums charged by the insurer are much lower than with ‘standard’ level term cover.
With a level life insurance plan the amount of cover under the plan remains fixed throughout the term of the policy. For example, if £100,000 of life protection is taken out at the start of the plan, £100,000 of cover will still remain at the end of the plan. As the level of cover remains fixed (rather than declining like with decreasing term cover) the premiums are a fair bit higher relative to decreasing cover.
The primary purpose of decreasing term mortgage insurance is to cover a principal repayment mortgage loan. In fact, decreasing policies are often just referred to simply as mortgage life insurance plans.
With a capital repayment loan the amount of debt outstanding declines over time to zero at the end of the loan term, and therefore so should the amount of mortgage life cover for strict cost-effective mortgage protection purposes. As decreasing term plans usually assume a policy interest rate of 8 to 10 per cent there should be sufficient flexibility for mortgage interest rate fluctuations.
Level term insurance plans are often used for family protection purposes and are often taken out just after the birth of a child, for example. However, as the level of cover remains fixed they are ideal to cover an interest-only mortgage loan. With this type of loan the amount of debt outstanding remains fixed, and therefore so should the level of mortgage life cover.
It is not uncommon for some people to have a proportion of their mortgage on a repayment basis and the remainder on an interest-only basis. In this instance the most cost-effective method of gaining cover is usually to take out decreasing term cover for the repayment amount and level term cover for the interest-only amount.
Although it is slightly more cumbersome considering two separate mortgage term insurance plans it does allow for savings to be made relative to just taking out one level term mortgage insurance plan covering the full (combined) mortgage amount. If both plans are placed with one insurer there would only be the need to complete one application.