Protection Needs

Because the purchase of a main residence is such a fundamental requirement for most people, and because the size of the borrowing is often large relative to income and other assets, it is important that the repayment of the loan be protected against a number of circumstances.

Life assurance

The risk of the borrower (or one of the borrowers) dying before the mortgage is repaid is significant. Because of the impact this is likely to have on the financial situation generally of the survivors, it is normal to protect the mortgage by means of life assurance.

If the loan is arranged on a repayment basis, then decreasing term assurance is suitable, since the amount of the debt will decrease during the term. Specifically tailored mortgage protection policies are available and these provide a sum assured which decreases at the same rate as the loan, assuming a given interest rate. Some care is necessary to ensure that account is taken of any changes in interest rates or that the policy contains a guarantee that the sum assured will at least meet the outstanding balance of the mortgage.

If the mortgage is arranged on an interest-only basis, the capital outstanding will remain constant, and level term assurance may be appropriate.

If the repayment vehicle is an endowment assurance, then life cover will automatically be built into this and there will be no need to make separate arrangements.

Where the investment vehicle would provide a return of the value of the investment in the event of death, there is a case for decreasing term being arranged to top up the return of fund to the required amount of the capital outstanding. However, particularly if the repayment vehicle is subject to fluctuations in value as would be the case with an ISA or a unit-linked pension arrangement, it can be difficult to ensure that the total amount available on death is sufficient. Level term therefore represents a more certain approach.

A further consideration is that, where the capital outstanding increases during the term of the loan, for example with a deferred interest mortgage, the life cover should be set at a level that exceeds the initial borrowing and covers the maximum expected level.

Disability

The impact of disability on a borrower can be very dramatic, yet relatively few mortgages are protected against its effect.

It is usually possible to include a waiver of premium option on any life assurance policies associated with the mortgage, and this can also be included on a personal pension, where this is the chosen method of repayment.

Permanent health insurance (PHI) remains important however to ensure that interest repayments can be met and that investment contributions to repayment vehicles that do not include waiver can be maintained.

Critical illness benefit could also be arranged, so as to allow the loan to be repaid in the event of the diagnosis of any of the specified conditions.

Redundancy

To a limited extent, mortgages can also be protected against the effect of redundancy. Cover is restricted however and will generally provide the necessary mortgage repayments for a period of one or perhaps two years. It is also important to be fully aware of the terms of the redundancy insurance since there will often be exclusions, particularly where redundancy occurs shortly after establishing the insurance protection.