Mortgage Guides

Mortgage protection - Do I need it? And if so, why?

Updated: Tuesday 20 September, 2011

By Seamour Rathore seamour@consumerchoices.co.uk

There’s no avoiding it - as the fallout from the financial crisis continues to put the focus on job security, we should all examine our need for mortgage payment protection insurance (MPPI).

In 2010, some 36,300 homes were repossessed and 169,600 mortgages ended the year in arrears, according to the Council of Mortgage Lenders (CML). The last thing anyone wants to do is fall into mortgage debt while the economy continues to struggle to recover from recession.

If you fall into financial difficulty and can’t pay your mortgage, many lenders will only give you a few months’ grace before commencing repossession proceedings. Although lenders are under pressure to ease off this timetable, there are no guarantees, although government action has made repossession tougher.

In this guide we’ll look at whether you should consider a mortgage protection policy and how much it will cost.

• What is mortgage protection cover?
• Who needs mortgage protection cover?
• Mortgage protection cover – key features
• What are the downsides of mortgage protection cover?
• Getting the right mortgage protection for you
• A more open market for mortgage protection cover
• Mortgage protection cover: What it isn’t

What is mortgage protection cover?

Mortgage payment protection insurance is a policy that pays out a monthly sum to cover your mortgage if you can’t work due to illness, injury or redundancy. It is also known as accident, sickness and unemployment cover (ASU).

It’s different from many other types of cover, such as income protection, as it will only pay out for a specified period of 12 months (24 months in some cases) so should only be seen as a financial stop-gap until you get a new job or recover from ill health.

The last government devised a scheme aimed at households who experience a significant but temporary loss of income - for example due to redundancy or compulsory reduced hours, but not long-term illness. However, even if you get help from the 1085”>Homeowner Mortgage Support (HMS) scheme you will still have to find the money to cover all your other bills and living costs.

To be eligible for MPPI you will need to switch to an interest-only mortgage and must also be able to show your household’s income has dropped substantially (but temporarily) and that you cannot meet the current monthly payments on your mortgage. You must agree to pay as much as you can afford and it must be at least 30% of the interest due.

Once you are back in employment, the interest will be compounded and added to the overall mortgage debt.

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Who needs mortgage protection cover?

In January 2009, the government introduced a temporary measure that reduced the time you’ll have to wait for state benefits to cover your monthly mortgage interest, known as Support for Mortgage Interest (SMI). In the past this was nine months, but it has been slashed to 13 weeks.

Nevertheless, there are rules for eligibility (an upper limit of £200,000 and SMI only pays mortgage interest up to a rate of 3.63%) and you will be means-tested (you can’t work for more than 16 hours a week and have more than £16,000 in savings).

So, if you have a partner who earns enough to cover the mortgage interest or you have savings, you will not be entitled to state help. Also, this help will not be available if you have a mortgage protection policy in place which would do a similar job.

Don’t confuse mortgage protection with life insurance, as mortgage protection does not provide a payout in the event of death. If you have dependents you should make sure you have adequate life insurance in addition to any mortgage protection policy.

Mortgage protection cover – key features

You are under no obligation to take out mortgage payment protection insurance (MPPI) from your mortgage provider at any point, including when you are taking out a new mortgage. Shop around independent product providers to find the best deal.

• The cost of cover is not governed by issues like health, age and whether or not you are a smoker
• The cost of cover depends on the size of the mortgage. It will cost between £3-£7 per £100 of monthly interest payment, so you can pay as much as £50-60 per month. As an example, if your mortgage payments are around £800 a month you could pay anywhere between £24 and £56 a month
• MPPI usually pays out for 12 months, but policies which pay out for 24 months are available
• Mortgage payment insurance is different from mortgage life insurance which insures your mortgage in the event of your death
• You can add extra cover for regular bills as well with some policies

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What are the downsides of mortgage protection cover?

MPPI is not designed to pay your mortgage until it’s finally paid off, just for 12-24 months (depending on the individual policy) if you are unable to work.

• You won’t be covered if you take out a policy after you have been told there is a risk you could lose your job or if your employer has revealed it is planning redundancies
• There is usually a period of around three months from taking out the policy before you can make a claim on it - this is the “qualifying period”
• There is usually a period between making a claim and getting your first payment - this is the “deferred period” and is to prevent the insurer paying out if you’re only out of work for a couple of weeks
• An income protection policy may offer better cover for you, depending on your circumstances
• In the event of illness, many employers will give you sick pay beyond the statutory requirement - this means that you may not need the MPPI to kick in before you have recovered, i.e. you may find yourself over-insured
• The devil is in the detail - you need to read the small print so you know what is and isn’t covered, i.e. dangerous sports, existing medical conditions, self-employment, and so on

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Getting the right mortgage protection for you

There is a multitude of life and protection products available of which MPPI is just one. It’s important to get the right policy, or mix of policies, for you.

This will differ according to whether you have dependents and whether your family has other sources of income. You also need to identify the areas where you are more likely to need protection in the future.

The cost of each type of cover can vary enormously and some forms of life insurance depend on your health and lifestyle. Consider consulting an independent financial adviser to review your protection needs and get the right policy/policies for the best cost.

You should ask yourself the following questions:

• How much mortgage cover should I have?
• Which protection policies should I have?
• Which provider is the most appropriate for me?
• Perhaps you would rather save up yourself (self-insure) to have a financial cushion if you are made redundant rather than regularly pay into a policy. This may suit those with a partner who earns a good salary (so could carry the cost of the mortgage) or if your employer has a generous sickness benefit policy in place

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A more open market for mortgage protection cover

The way that mortgage protection cover has been traditionally sold has been under scrutiny in the last few years. The Competition Commission ruled in November 2008 that MPPI could no longer be sold at the same time as a mortgage.

Mortgage providers now have to give you 14 days after you have agreed to a mortgage before contacting you about mortgage protection. This gives you time to shop around and find the best deal for you, rather than being rushed into a purchase.

Banks have long made substantial sums from selling various types of protection policy - as much as one-fifth of their profits have been coming from these types of policies, according to one study by Morgan Stanley.

So, while you may need this type of cover, do your homework carefully and shop around for the best deal for your circumstances and finances.

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Mortgage protection cover: What it isn’t

It’s easy to get confused by all the different types of life cover and protection policies, but remember mortgage protection cover is not any of the following:

Life assurance: Pays out a sum to your dependents on your death

Critical illness cover: Pays out a lump sum if you contract a serious illness, a list of which will be outlined in the policy documents. This can be used for any purpose i.e. paying off all/part of a mortgage, paying other bills, paying for non-NHS treatment. Critical illness cover can be expensive.

Income protection or permanent health insurance: Based on a medical questionnaire, occupation, age and other risk factors this is a policy which pays around 50%-65% of your income if you can’t work due to illness or accident. It does not cover you for redundancy; however, you can bolt this on as an extra, but at further cost.

Income protection can be expensive, particularly if you are considered a high risk. But unlike MPPI, which has a defined period in which it will pay out (12-24 months) before it stops, income protection will pay out until you return to work or you retire or until your mortgage is paid off, whichever is the sooner.