Legal fees, property transfer costs, stamp duties: the costs of buying a home can add up to an unexpected amount, and that’s before most consumers even look at insurance.
Insurance is in fact often viewed as a grudge purchase and, while the average homebuyer does realise its inherent value, he is often not equipped to effectively measure intangible risk against tangible cost.
Financial consultants are frequently asked whether mortgage protection insurance (MPI) is really necessary if the home buyer has a life insurance policy, and the answer is relatively simple. Insurance is all about understanding your profile, knowing your desired outcomes and covering the right risk element and, if your current insurance portfolio does not protect your home for the duration of your loan, you need the additional protection of MPI.
Knowing your profile and needs is key. Life insurance requirements are generally calculated based on income replacement requirements, which typically increase over time. Bond cover, on the other hand, is taken to cover a specific liability and it is generally a decreasing cover requirement.
In the most basic terms, life insurance covers the risks of general income loss and MPI covers the specific risks associated with home loan debt.
There are certain advantages to using a MPI policy as opposed to an existing or new life policy to cover debt over an asset. Under an individual life policy, either the cover or the premiums tend to increase every year as factors like age affect the risk profile, while the debt that you are covering – the loan on the house – generally reduces.
Under an MPI policy you should only pay premiums for the cover that you need – ie: on the reducing bond amount. Premiums are also only due when the bond registers, and the policy can be cancelled at any time, without penalty.
The effect of risk profiles on premiums for individual life policies also means that insured parties are often required to undergo a medical examination to obtain cover. For cover under MPI, as a result of the lessening of the anti-selection risk on the insurer (in that the client has to have a bond approved to get the cover), the products often allow for guaranteed acceptance without the need for medicals up to certain limits, combined with limited pre-existing condition exclusions.
Additionally, in the case of an individual life policy, one needs to arrange for specific cession of the policy, to the extent of the indebtedness under the bond. If no cession, the benefits will be paid to the beneficiaries or the estate, and the executor will be liable for keeping up the bond repayments. MPI is usually automatically ceded to the bank to cover the outstanding liability directly.
Cover the risk
Individual life policies can also include an added premium for an investment element when one might merely want to cover the risk at the most affordable price. Again, this rests on desired outcomes. If the insured party is looking to protect dependents from existing debt, then an MPI policy might make more sense as it simply covers the risk of the reducing outstanding loan balance at the most affordable premium.
MPIs can also offer valuable benefits such as retrenchment and temporary disability cover, which are rarely found in individual life policies. Under the MPI policy, the benefits payable under these covers are linked to the monthly home loan repayment so, as interest rates rise, the value of these benefits will also increase (at no additional premium). The cover on the policy thus always matches the liability of the home loan.
Ultimately, MPI may not be suited to all people, but in one way or another, all homeowners should have adequate protection in place, should unforeseen life changing events occur. In this case it’s important to remember that the property is the investment and the key is to protect the investment.
Republished with the permission of Home Front, November 2004
Written by Mortgage SA, now known as ooba