The excitement of purchasing your first home can quickly disappear after you realize the responsibilities of home ownership. One of the things that soon becomes apparent after successfully securing a home is the need to protect your investment. Purchasing a home will start the insurance conversation if you’ve avoided it or never had a reason to discuss it before.

When it comes to protecting your home, you have two primary options. The first option is to get mortgage insurance. The second option is to go with a term insurance policy. If you’re purchasing your first home, especially as a young buyer, you’re likely to select mortgage insurance by default or at least likely to be pushed towards that option. But is that the best option? Before I give you the answer, let’s review the two options more in-depth.

What is mortgage insurance?

Mortgage insurance is insurance coverage against your mortgage in the event you die. Most of the mortgage insurance offered by financial institutions will also offer some form of disability coverage if you become disabled and unable to work. However, disability insurance isn’t indefinite, so please look at the insurance policy in detail.

Here are a couple of things to keep in mind regarding mortgage insurance. First, mortgage insurance is insurance coverage against a debt. As its name indicates, the debt is the mortgage. Any proceeds or benefits from the policy will be used to pay off the debt and cannot be used for anything else. That means if there’s a payout, it has to be used to pay off the mortgage and nothing else.

Additionally, mortgage insurance premiums do not change as long as they are in effect, even though the mortgage balance will decrease over time. For example, if you purchased a $100,000 mortgage insurance policy and after 10 years, you die with only $60,000 left on the mortgage. The mortgage insurance will pay the $60,000 mortgage even though your premium is based on $100,000 coverage. There’s a $40,000 gap that isn’t recoverable to you even though you’ve paid premiums based on $100,000 coverage.

What is term insurance?

Term insurance is life insurance coverage that provides a fixed coverage amount, at a fixed premium, for the term of the insurance policy. Term insurance is usually anywhere from 10-30 years but can be longer or shorter. There are some term 70 policies which offer life insurance till age 70. But since I’m talking about mortgage insurance alternatives, the most common term selected is usually 30 years to match of the mortgage term. As an alternative to mortgage insurance, you get a term life insurance policy with a similar dollar amount as your mortgage and a term to match your mortgage.

Here’s how it works. You bought a house for $100,000 with an amortization term of 25 years. Instead of getting mortgage insurance, you look for a term life policy for $100,000 for 30 years. If you died, your beneficiary would get a $100,000 payout, which they can apply towards the mortgage.

The main thing to understand with term life insurance is the policy against your life, not the mortgage debt. That means the proceeds can be used by your beneficiary towards anything they choose. Your beneficiary is not required to use the payout to cover the mortgage debt. The money can be used for anything.

Furthermore, the amount of coverage stays the same. For example, if you purchased a $100,000 term 30 life insurance policy and died after 10 years with only $60,000 left on your mortgage. Your beneficiary would receive a $100,000 cheque, which they could use $60,000 of it to pay off the existing mortgage balance and would still be left with $40,000 to help with any other expenses.

Mortgage Insurance or Life Insurance: Which option is better?

It’s best to answer this question by sharing my personal experience. I have a term 70 life insurance policy. My wife and I were relatively young when we purchase our house, which made the term insurance price attractive. Before deciding to go with term insurance, we considered all options, including whole life insurance. We decided against mortgage insurance for two main reasons; cost and flexibility. Our mortgage insurance which included some disability coverage, amounted to about $300 or $400 per month for the two of us.

The mortgage insurance would have continued making our mortgage payments in the event one of us died. While I felt comforted by that, I wasn’t feeling great as my wife would still have to get additional insurance to replace my salary for years and any additional funeral costs.

We also consider where life might take us in the future. If my wife and I were to have kids in the future, we would need additional money to help raise the kids should one of us not be around. Having the mortgage paid would not be enough as my wife or I would still need to work and would require additional cash to keep things going.

When we considered all those things, we realized that having mortgage insurance did not offer us the flexibility or coverage required for the short or long term. We wanted to take advantage of our age to have a reasonable premium while also trying to secure as much insurance as possible for future needs.

Also, if we picked the mortgage insurance option and decided to upgrade our house or purchased a house that was more expensive than the original mortgage, we would be required to apply for mortgage insurance on the new amount. We would likely be older, and the new mortgage amount might be too expensive for us or worse, we might not qualify due to health issues.

To our surprise, getting a term 70 life insurance policy was actually much cheaper than the mortgage insurance; it came in at around $189 for the two of us. We ended up getting much more life insurance than we needed at the time, but it would secure our future needs. We tried our best to anticipate our future needs and purchased a policy amount that exceeded our needs at the time but today is only slightly above what we need.

For disability coverage, we also shopped around, and some products included disability and life insurance, but we found them to be too expensive for our budget.  We decided to use our work disability plans and supplement them with additional savings and a line of credit. We both selected the maximum amount of coverage available in our work plans, which for me is 60% of my wages that’s indexed to inflation. That’s not a lot since most of us live on 100% of our net income. That being the case, we decided to open a line of credit to provide us quick access to emergency funds and put in place a plan to save enough cash on hand to provide us liquidity to deal with emergencies.

For my wife and I, term insurance was the right option. But when it comes to insurance coverage, you want to look at your entire life needs and avoid getting insurance in isolation.

What to Know About Getting Mortgage Insurance and Term Insurance

You should always sign up for mortgage insurance when applying for a mortgage. You do not want to be approved for a mortgage or sign a purchase agreement without some coverage. Even if you plan to go with a term policy, opt for the mortgage insurance your lender is offering in the meantime. If you currently have mortgage insurance and are considering getting term insurance, do not cancel anything until you’ve been approved.

The key with insurance is to ensure you have enough to cover your immediate needs and additional expenses. You also need to factor in income replacement income. If you get term insurance for your mortgage, don’t simply get a $300,000 policy because you have a mortgage for that amount.  Think beyond your mortgage. What about your spouse, your kids, and any other expenses that might result from your death? Your family might need a couple of years to figure things out, so factor in a reasonable income amount that would provide them time to grieve without worrying about money.

When it comes to how much you spend on your policy, it’s different for everyone. Spend enough that makes your family secure, but don’t spend so much that you have too much insurance. Aim for balance as with anything in life. Insurance isn’t fun for people to talk about. This might sound like a promo or endorsement, but it’s true. When someone you love dies without insurance, it can put a lot of financial pressure on people who depend on you. I say that from experience.

Therefore, spend the time to discuss insurance and ensure those you love will be protected if something happens to you.