Like most types of insurance, mortgage insurance is about managing risks and enjoying peace of mind. There are two very different types – lenders’ mortgage insurance (LMI) and mortgage payment protection insurance. LMI is more about managing the lenders’ risks when they provide low deposit mortgages. Payment protection insurance is designed to help keep your mortgage payments going if certain things, such as an illness, stop you earning income for a while.
This guide deals mainly with payment protection insurance and how to get the best policy for your needs. But to help avoid any confusion, we’ll start with a brief description of lenders’ mortgage insurance.
What is lenders’ mortgage insurance (LMI)?
If your deposit was less than 20% of the property’s value, and you can’t continue your mortgage payments, there’s a greater chance the lender might not be able to get their money back by selling your home. That’s because house prices might fall below the amount you owe.
To reduce their risk, the lender will charge you a higher interest rate. The difference is known as a low equity margin (LEM). It will typically range from an extra 0.25% to 1.25%, depending on how low your deposit is. Sometimes the lender will charge a one-off fee instead. This is simply added to your mortgage and usually ranges from 0.25% to 2.00% of the amount you borrow. Again, the lower your deposit the higher the percentage will be.
The First Home Loan product, which offers a 5% deposit to qualifying first home buyers, is underwritten by the crown entity Kāinga Ora. That means they carry the risk and only charge a one-off fee of 1.00% of the loan, which is simply added to the amount you borrow.
What is mortgage protection insurance?
Every policy is different and the premiums charged can vary a lot. But in general, mortgage protection insurance will cover your payments if you no longer can, because of an unexpected illness, mental health condition, disability or (sometimes) redundancy. It’s not just for low deposit mortgages. Each policy will have its own conditions and exclusions, so be sure to read them carefully. Most insurers also offer options you can choose from, which we discuss in more detail below.
It’s important to shop around to get the best solution for your needs and risk appetite, as well as the best deal. While your mortgage lender may be keen to sell you a policy, you don’t have to buy their solution if you don’t want to. In fact you don’t have to have mortgage protection insurance at all. It’s not compulsory, just a good financial strategy for many people.
What does mortgage insurance cost?
This will depend on a range of things, such as:
- Your age
- Your occupation
- How much your mortgage payments are
- How long you agree to wait for the insurance payments to start after you make a claim (the wait period)
- The maximum time the payments could continue for (maximum payment period)
- Whether the cover also includes when your partner loses the ability to earn their usual income due to an event listed in the policy, such as unexpected illness.
To give you a rough idea, for a mortgage of $400,000, monthly mortgage payments of $2,200, a wait period of eight weeks and maximum payment period of two years, an accountant aged 30 might pay somewhere between $180 and $380 a month.
The best way to work out the cost is to find policies and options that suit your needs from several insurers and ask for quotes. Rather than shopping around yourself, you might find it easier to talk with a good insurance broker who represents most of the main insurance companies. It’s always important to get professional advice before making any financial decision and there’s usually no extra charge to you for using an independent adviser.
What else can help to cover mortgage payments?
Before diving into mortgage protection insurance, it’s important to consider how it would fit with your wider financial protection plans. That usually means getting some professional advice on the best way to protect your financial future. Based on your current situation, preferences and goals, it can help you identify the most important insurance policies for your needs.
In the meantime, here’s a quick look at other types of financial support that might help with mortgage payments if you can’t work for an extended time.
Paid sick leave: Unless you’re self-employed, you’ll probably have some form of paid sick leave to cover time off work for a while. This can help you extend the wait period you select for mortgage payment insurance, which will reduce your premium. Be sure to check your sick leave allowance before choosing a policy. But bear in mind that you may use up some of your sick leave allowance, for minor illnesses during the year, before a long term illness strikes.
Work and Income NZ sickness benefits: Given these are only $100 to $150 a week, they’re unlikely to cover your mortgage payments.
ACC payments: ACC doesn’t cover loss of income due to illness. Instead, they focus on loss of income due to injury. They usually pay up to 80% of your usual income if you can’t work due to a covered injury. To some extent mortgage payment insurance can fill the gap that ACC leaves.
Life insurance: Life cover typically pays out a lump sum when you die or are diagnosed with a terminal illness. While that can certainly help cover mortgage payments, many illnesses that could prevent you working for an extended period are not included in the cover.
Health insurance: Some policies include a lump sum payment if you’re diagnosed with certain illnesses. If you have health insurance, you should check the policy details before choosing mortgage payment insurance.
Income protection insurance: This will usually pay about 75% of your normal income if you’re unable to work due to severe illness. That’s normally more than you’d need to cover mortgage payments, so the premiums are likely to be higher than for mortgage payment insurance with the same wait period and payment period. However, you might like how this type of insurance covers most of your living costs, not just the mortgage payments.
Redundancy insurance: Income protection insurance doesn’t normally cover loss of income if you’re made redundant. Some mortgage payment insurance policies do include redundancy cover, but not all. You can also get a separate redundancy insurance policy if you wish. It might depend on the nature of your work and how high redundancy cover is on your list of priorities for insurance.
Savings: Many specialists recommend building up an ‘emergency fund’ that could cover your essential expenses for something like three months. If you’ve been able to do this, it might allow you to choose a longer wait period and reduce your mortgage or income protection insurance premiums. However, that could mean you have to rebuild your emergency fund while living without the peace of mind it provides.
What’s not covered by mortgage protection insurance?
These are known as exclusions. Again, every policy will be different, so be sure to read the fine print carefully. Here are the more common exclusions:
- Lost income due to pregnancy
- If you fail to follow the recommendations of your treatment provider
- If the claim is directly or indirectly related to criminal behaviour
- If you’re imprisoned
- If you deliberately injure yourself or attempt to do so, including attempted suicide
- If the claim is related to a medical condition you already had when you took out the policy
As we’ve already mentioned, it’s important to get experienced advice and to consider mortgage protection insurance as part of a wider plan. Talk with friends and family about their insurance decisions and experiences. Ask if they know of a good insurance adviser or broker,who could help you plan ahead and get the exact cover you need for a good price. Even a small saving on the annual or monthly premium can add up to quite a bit over the life of your mortgage.