Term Assurance
Capital repayment, pension and ISA mortgages all require life cover to be added to ensure that the loan is paid off if the client dies during the mortgage term. Although it is not usually a condition of the mortgage loan, most lenders strongly recommend it.
Although whole-of-life cover could be used, term assurance is considered by many borrowers to be the most appropriate as this is the least expensive form of life assurance and will provide the necessary cover for the term of the loan.
For capital repayment mortgages, the amount of the loan decreases overtime and the borrower therefore has a choice between a mortgage protection policy, where the sum assured decreases in step with the outstanding debt (Decreasing Term Assurance), and a (more expensive) level term assurance set at the level of the initial loan. Level term assurance will in this instance provide cover increasingly higher than is required to repay the loan with the excess being payable to the estate.
Most life assurance policies also offer waiver of premium benefit at an extra cost. This covers premiums if the borrower cannot work due to accident or disability.
Mortgage protection policy
Under a mortgage protection policy the outstanding loan will be repaid on death within the term if loan repayments are maintained. At the end of the term, the cover expires and no further premiums are payable. The policy acquires no value and therefore there is no surrender value. If premiums are stopped during the term, cover stops with nothing being paid back to the borrower.
The rate at which the loan is repaid depends on the rate of interest; the higher the rate of interest, the slower the loan diminishes and vice versa. On the face of it, it would seem that premiums and cover would have to fluctuate as interest rates fluctuate. To avoid the problems this would cause, insurers base their premiums on an assumed rate and guarantee that premiums will not go up unless interest rates exceed, say, 12% p.a.
Although it is possible to assign the policy to the lender, so that the monies were paid to it, most lenders do not require this. It should be noted that a mortgage protection policy may not cover the whole debt if arrears are due at the time of death.
Level term assurance
Although some borrowers may wish to provide more cover on death than required to repay the capital repayment mortgage by effecting a level term assurance, they are more appropriate for pension and ISA mortgages where the amount of the outstanding loan does not decrease.
When linked to a personal pension or stakeholder mortgage, pension term assurances may be used. However, the maximum premium for term assurance linked to pensions effected on or after 6 April 2001 is 10% of the premium to the pension contract. Personal pensions effected before this date could (and still can) allow a life assurance premium of 5% of net relevant earnings (NRE) within an overall maximum percentage contribution based on age. Thus, if the maximum rate which can be paid is 17.5% of NRE, a maximum of 5% per annum can be spent on pension term assurance, leaving a maximum of 12.5% which can go towards retirement provision.
Premiums paid towards pension term assurances receive tax relief at the individual's highest marginal rate.
Pension term assurance can be assigned to the lender, but lenders usually do not insist on this.
ISAs also require term assurance to be added as the likelihood is that, if the borrower died during the term, the ISA would not have grown enough to repay the loan. As the ISA fluctuates in value, it makes sense to use level term assurance, although some providers do use mortgage protection policies in conjunction with ISAs. Life companies often market ISA and mortgage protection together as one product under a brand name. The term assurance in this case will receive no tax relief.
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