Purchasing a home can be the most important financial commitment of your lifetime. With mortgage terms available as long as 30 years, the lender is counting on your ability to make payments for a very long time. This in turn relies on your long-term ability to earn an income. When circumstances are such that you cannot afford your payments, mortgage insurance can become a valuable financial protection plan allowing you to keep your home.
Protecting the Lender
Mortgage insurance protects the lender, not you as a homeowner. When you buy a home, you must generally make a down payment. If that down payment is not at least 20 percent of the purchase price, the lender will require you to purchase private mortgage insurance, commonly called PMI, to protect it against the possibility of your default. The lender requires PMI because a loan-to-value ratio of less than 80 percent increases the risk of default on the loan. PMI is a cost that the lender adds to the mortgage amount, typically by charging a one-time fee equal to a percentage of the loan that's usually anywhere from 0.15 to 2.5 percent. You repay these charges with a slightly higher monthly mortgage payment.
Other types of insurance can cover you against the possibility of a financial disaster. If you were to die prematurely, for example, your family would be suddenly cut off from your income. This can cause significant financial hardship, and the mortgage on your home can be the first casualty. Consult with a qualified life insurance adviser who will outline for you the various options available to protect your mortgage in the event of your premature death. Since your mortgage may only last between 20 and 30 years, one of the most affordable and useful solutions could be a term life policy. The premiums are lower than whole life coverage, and a term policy is usually purchased to cover relatively short-term needs such as an outstanding mortgage debt.
A serious accident or illness could cause you to be unable to work for a long period, even permanently. This can be even worse on family finances than your death, because you are faced with potential additional medical expenses on top of having to meet everyday expenses such as the mortgage. A policy for disability insurance, or income replacement, can provide monthly benefits that replace your loss of income should you be unable to work due to accident or illness, allowing you to continue making your mortgage payment and remain in your home.
Sometimes a major illness, such as some forms of cancer, can have devastating financial ramifications, but actually not be enough to qualify you for disability insurance payments. A disability insurance policy may deny you benefits because you would technically still be able to continue working, but the prohibitive costs of treatment may force you to sell your home. A policy covering critical illness pays a lump-sum benefit on the diagnosis of a major illness, and can provide much needed up-front cash to keep you from selling other assets.
Philippe Lanctot started writing for business trade publications in 1990. He has contributed copy for the "Canadian Insurance Journal" and has been the co-author of text for life insurance company marketing guides. He holds a Bachelor of Science in mathematics from the University of Montreal with a minor in English.