Why do I need to take out life insurance for a mortgage?
[social_share]Some mortgage providers will ask a home buyer to take out life insurance to cover a home loan. This tends to happen in some very limited circumstances.
Home loans are unusual as a form of consumer credit for a number of reasons. Firstly the amount of money loaned is very high, often three or four times the home buyer’s annual income. A mortgage also has a low interest rate compared to most other types of lending. Finally, it’s paid off over a very long period of time, usually between twenty-five to thirty years, or in effect most of a person’s working life.
As well, home loans are secured on a house. If the homeowner defaults on the loan repayments, the lender can take the house back and sell it on the open market. This has two effects. Firstly, the homeowner will make more effort to pay their home loan than they would almost any other form of borrowing. Secondly, the loan is very likely to be paid off even if the homeowner defaults on the loan.
For these reasons, the deposit on the house becomes very important. The deposit is the difference between the house value and the home loan extended. A higher deposit discourages the homeowner from defaulting, and if they do default then the loan is still likely to be paid.
A loan with a low deposit therefore becomes more like a personal loan, in which a bank is lending on the credit of the borrower. As home loans can be very high indeed, when the applicant is negotiating for a home loan with a low deposit they will usually be carefully checked for having an acceptable credit history as well as a high and stable income. The biggest issue then becomes if the buyer dies.
This is why in cases of low deposit loans, the mortgage lender will tend to ask the buyer to purchase life insurance to cover the risk. The borrower will pay for the life insurance and the beneficiary will be the mortgage lender.
