Why should one buy mortgage term life insurance? The answer to that question is pretty obvious to most people but just in case there is anyone who doesn’t know let us look at the what this policy provides. The intent of the designers of mortgage term life insurance was to create a policy that would be very inexpensive and at the same time would provide sufficient death benefit to pay off the mortgage in the event of the death of a breadwinner.
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Life insurance was designed with the protection of the family first and foremost in the minds of it’s creators. I believe it was fraternities that first explored the idea because they saw the difficulties that families experienced when a wage earning parent died. They figured that if a group of people got together and contributed to a fund over a period of time that money could be used, at minimum, to cover burial cost of the deceased and much pressure would be taken off the shoulders of the surviving family. At some point later someone came up with the idea to have mortgages paid off in the event of the death of a breadwinner. Let us look at how mortgage life insurance works and in particular mortgage term life insurance.
As the name mortgage term life insurance implies this is very inexpensive life insurance. Term is the cheapest type of life insurance. This is close to the purest type of term insurance that exists. The premium of this policy remains level throughout. The mechanics are best illustrated by detailing an example…
Let us suppose you bought a house for $200,000. You have good credit and a good job so you decide to make a down payment of $40,000…20%. You owe $160,000 which you intend to pay off over a 20 year period. The amount you pay each month will depend on the rate of interest the bank charges but for the sake of this illustration that is beside the point.
In the initial years the majority of your payment is going to interest. As the years go by, and the principal decreases, a larger portion of your payment actually goes to reduce the amount owed to the bank or mortgage company.
In the initial years the life insurance company is bearing greater risk. The natural thought is that you should be paying a higher premium for your policy at the beginning. Not so. What the actuaries have done is to calculate the cost for the risk the insurance company is bearing each year for the 20 year period. They charge you an average, thereby allowing for a level premium over the 20 year period. Calculating the premium is a little more complex than that but, in a nutshell, that is how it works.
The Death Benefit
Bear in mind that your mortgage term life insurance policy was intended to pay off your mortgage in the event of your death. That is exactly what it will do. The death benefit of the policy decreases each year; thus the popular name for this policy… decreasing term insurance. The amount paid by the insurance company upon the death of the insured is equal to, or close to, the amount owed to the bank or mortgage company…
Let us use the same $160,000 mortgage as an example. If the insured died within the first year the amount paid would be equal to the amount owed at that time…$160,000. If the homeowner died in the tenth year the amount paid by the insurance company would also be equal to the amount owed but that amount at that time would be much less. I guess something close to $100,000. You would need to look at mortgage tables, and consider the interest rate, to arrive at an accurate figure…
The beauty of the whole thing is that the survivors will have a house free and clear.
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