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Listen below as Michael Webb talks all about Mortgage Protection.
Why is mortgage protection so important?
The main reason is that you’re protecting your home and your family. There are a few things that we would advise on as mortgage brokers, and mortgage protection is one.
Mortgage protection includes life insurance, critical illness cover, income protection and perhaps an accident/sickness/unemployment policy to cover your mortgage. Buildings insurance is compulsory when you have a mortgage – a bit like your car insurance is compulsory – in that the lender wants you to insure their asset.
But what you can see from that single bit of compulsory insurance is that the lender really doesn’t have too much interest in you as an individual, as long as their asset is insured. Then they can always take it back from you in repossession if the mortgage can’t be paid.
That’s why mortgage protection is so important – because things can go wrong in our lives no matter how old we are. That lender will not hesitate to take your home from you to get their money back. You are just an account number on a computer. So we encourage people to take responsibility for their own circumstances, such that the lender’s never in the situation to do that.
What if my mortgage has been completed without protection?
Typically there’s a hierarchy of requirements depending on your situation. If you’re a single individual with no dependents, life insurance is probably the last thing you should be looking at. That’s not to say you shouldn’t have it, but we will work to your budget. The first thing you protect is your income, as you are the only source of income into the household.
If you’re a family, and maybe one income is higher than the other, the dynamic changes and life insurance moves up the list of importance. We would have a more in-depth conversation with you around budgets and what’s important.
We need to think about the consequences should the worst happen. As a single individual, if you were to die you’re leaving a problem for your family to deal with. Your property can’t pass probate with a mortgage on it, so it would need to be sold to settle the mortgage. That means you can’t leave your property to someone else. A life insurance policy would pay that off and allow you to maybe leave your home to a sibling, parents or another relative.
For that individual, possibly a worse situation is having a car crash and not being able to work for a year – so there is no income coming into the household.
In the family situation, should one of the parents die that changes the finances of the family. The mortgage might require both incomes to be affordable. Without life insurance, there is real pressure on your ability to remain in that home.
You will have had an in-depth conversation with an advisor when taking out the mortgage about your obligations to pay it back. If you’re unable to keep up the repayments, the lender will have a court hand the property over to them, evict you from it and sell the property to repay the debt.
What is income protection?
An income protection policy in effect is giving you sick pay from your employment. Everyone who is PAYE employed will have an element of sick pay. Income protection is available for self-employed individuals too, but it works slightly differently so I’ll just focus on PAYE. But if you’re listening to this and you are self-employed, you need more in-depth advice, so do seek that out.
Let’s say you have four weeks’ sick pay from your employer at full pay. That’s fairly standard outside of government organisations where sick pay tends to last longer. You have a car accident and you’re unable to work for a year. You’re in a horrible situation, but you can claim an income up to a maximum amount and duration, depending on the insurer. You pay a monthly premium and the typical recommendation is for the policy to take you up to retirement age and cover your full net income.
You usually only cover a percentage of your income – because you can’t be off sick earning more than you would be at work. Then, after your four weeks’ company sick pay ends, you would possibly then go on statutory sick pay plus your income protection policy. That will broadly bring you in line with your ordinary net pay.
The policy has options to make it more affordable. You can limit the payout time so it only pays out for a couple of years rather than indefinitely to retirement. Or you can reduce the maximum age – if say you’re in your 20s and taking a 30 year mortgage, you can take a 30 year policy to cover your mortgage term.
We would have a conversation with you around your requirements and budget and what you can put towards insuring your income.
Just to be clear, this policy doesn’t cover redundancy – it’s just sickness and injury. A redundancy policy is a PPI policy and there are certain regulations around the sale of those.
It would be classed as a general insurance policy like buildings and contents insurance, rather than protection.
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Do I need critical illness cover?
Again you need to take advice on this, but in essence it will pay out a set sum for a specified critical illness, in line with the policy wording. You could receive a fixed sum, or if it’s a mortgage-related critical illness policy, the amount paid out will decrease in line with your mortgage. Typically they assume that the interest rates are around 8%, and that’s how they’ll decrease over time. Obviously rates are still much lower than that, so the policy is decreasing slower than you’re paying your mortgage off and there’s never a deficit.
The insurance pays out for a specified critical illness – and this is really important because the only way insurers can make a critical illness policy cheaper is to reduce the likelihood of paying out. So they might reduce the number of critical illnesses that are covered or state that critical illness must reach a more severe level before it triggers a payout.
To explain: some critical illness policies will cover blindness, and how they define blindness will vary. Some will require that you can’t see anything – just blackness. Others will require that you can’t read letters of a specific size from a specific distance.
So some policies are easier to get a payout on than others. It’s a really complex area because the insurers have set criteria. Brokers dealing with critical illness insurance will have a good understanding of the levels of cover and which companies are better for critical illness.
There still needs to be a conversation around cost and budget. If everyone took what the FCA suggested, it would probably be unaffordable on a monthly basis. A good advisor will have that conversation with you, and it’s now part of FCA consumer duty legislation – because otherwise, if something goes wrong you could lose your home.
How does critical illness differ from life insurance and income protection?
Very typically critical illness and life insurance are joint policies and there’s a reason for that. Say an individual has a stroke and survives, that critical illness policy would pay out if the stroke was sufficiently serious.
However, if that stroke kills the individual, a critical illness policy would not pay out. Whilst a critical illness could completely change your life and may eventually kill you, it shouldn’t kill you instantly. Most policies say you need to survive for 14 days on being diagnosed with that critical illness, otherwise it would be a life insurance claim.
Why is life insurance so important?
Life insurance isn’t a policy we take out for ourselves – it’s to protect those that we care about. Something I often say to clients is that we hope the mortgage protection that we arrange for people is a complete waste of money, and that they never need to claim on it.
If they do, it means something has gone dramatically wrong in their lives.
If you have a joint mortgage, you need to put insurance in place to protect the people left behind. It’s not just to settle the mortgage. If you have children and a family, they don’t just lose an income, they lose what you’re providing to the family in the form of childcare and other support, and that will completely change the dynamics.
Your partner may not be able to work as much and will need their income topped up. That’s where the family protection side of the conversation comes in. Yes, the mortgage is paid off but is there enough income to pay all the bills?
So there’s lots of conversations that need to go on and this needs to be taken seriously by people taking out debt. A professional advisor will walk clients through this insurance journey, establishing their needs and priorities and making suitable recommendations.
Can you combine policies? How does that work?
It’s common to combine life insurance and critical illness. Some people will still separate those because if they did get a critical illness, a joint policy will only pay out once. So you can separate them within a plan.
Using my previous example, if you had a stroke the critical illness policy will pay out. Then if a year later you die, the life insurance will pay out. Once you’ve had a critical illness you will find it exceptionally difficult to get a life policy, so it can make sense to separate them.
Income protection is never really joined with any other products, but they can all be under one plan. You don’t have to go to the same insurer. What could be most beneficial for an individual is based on the type of job they do. An income protection policy might be better with Insurer A, but the best critical illness policy might be with Insurer B – and that’s no problem. You can go with separate insurers within the same protection plan.
How much should I budget for mortgage protection?
It’s tricky to give a generalised answer, but when you’re looking at how much you’re spending a month on your mortgage, you should already be thinking how much to spend on mortgage protection. It shouldn’t be an afterthought, and should be part of the very early conversations with your mortgage advisor.
I suggest people look at how much they’re spending on other things to get some context. For example, we’ll go through people’s bank statements and they might be spending £40 on takeaway coffee each month, or £80 a month for their phone contract. Cutting back on those would give you a decent budget to put towards protection.
But of course the budget required to adequately protect yourself is going to be different if you have a £100,000 mortgage compared to a £1 million mortgage. So another approach is to look at whether 10% of your mortgage payment is affordable. If your mortgage is £800 a month, then spending £80 a month on protecting your home is a good place to start a conversation about budget.
The costs of these policies are risk related. If you’re 20 years old and taking a 25 year life insurance policy, the likelihood of you claiming on that is low. But that doesn’t mean you shouldn’t have it. Statistically speaking, 50% of the UK population will have a critical illness by the time they’re 65, so the older you are and the closer to 65, the more likely you are to claim. That’s why I would encourage younger people, who maybe see less need for them, to take out protection. It is much cheaper to take policies out earlier in your life.
What else do we need to know about mortgage protection?
With new changes to consumer duty legislation, mortgage applicants are going to see some changes in the processes they go through. Brokers will need to document the conversations they have about protection. There will be people that are defiant about not taking any form of insurance. They might not agree with it, but they will no longer have the choice not to have these things explained to them to understand the consequences.
To be fair, most competent brokers are very client-centric and switched on around these real needs for their clients. For them, the process won’t change much, but the documentation on the backend may increase a bit.
These conversations are not ten minute chats. You can’t establish someone’s requirements and make recommendations in that time. You need to sit down for an hour or so and really get into what’s important.
[Episode recorded in January 2023]
As with all insurance policies, conditions and exclusions will apply.
The cost of this insurance depends on several factors, such as your age, where you live and your occupation. As a result, the cost you will pay is based on your own circumstances.