Being as financially resilient as possible and managing financial risk is important for homeowners. This is particularly the case for people with mortgages who have leveraged their income to take out a large debt.
Insurance can play a key part for people who have shortfalls in their risk management plans. It’s important to understand the risks, how they apply to you and then insure yourself appropriately.
- Income Protection
Most people gravitate towards life insurance as a priority, particularly when taking out a mortgage. This could be because of the inevitability of death and/or our general fear of it.
However, in most cases, passing away during the term of a mortgage is actually the lowest risk in terms of probability.
In most cases, the higher risk is being unable to work for 2 months or more.
Income protection acts like sick pay. It is designed to pay you a monthly amount if you are unable to work due to incapacity and start after any existing sick pay benefit has stopped or personal resources have been exhausted.
Think for a moment about how you would cope without an income. Yes, you couldn’t pay your mortgage, but what about other essentials such as food and bills.
People tend to focus on protecting the mortgage and that is important, but neither your mortgage or your home puts food on the table. Protecting your income will protect everything that is important to you.
It is important to note, Income Protection does not cover redundancy and should not be confused with an Accident, Sickness and Unemployment policy (see below)
Income Protection should be a priority to anybody whose standard of living is dependent on their earned income.
- Family Income Benefit
Moving on to life insurance, Family Income Benefit is a different way to structure it compared to mortgage life insurance.
Most people look to take a lump sum payment to ensure the mortgage is paid off in full in the event of death.
Again, this is important to many people, but it’s worth taking a moment to consider this.
If the mortgage is paid off in full, this will lead to outright home ownership which is great, but this doesn’t put food on the table or pay the bills.
Arguably, it makes more sense to have an ‘income’ coming in that is sufficient to cover the mortgage payments as well as the vital costs of living, than it does to have a lump sum just to pay the mortgage off.
The irony of just taking out a lump sum to pay the mortgage off is that this could still lead to having to sell the home anyway, if there is an eventual shortfall in funds to cover the cost of living.
Family Income Benefit is life insurance divided into monthly payments to make sure that costs are covered for the time required.
It’s usually of particular interest where there are two or more borrowers and/or children (or other financial dependents) are involved.
- Mortgage Life Insurance
Usually the top priority for many people, this could actually be seen as number 2 or 3 on the priority list, but still essential where appropriate.
Again, in most cases, death is the least likely event during a mortgage term when compared to being off work due to incapacity or suffering a critical illness. This is why this form of cover tends to be the cheapest.
This policy is designed to pay a mortgage off in full in the event of death of a borrower so that the surviving borrower doesn’t face financial hardship or potentially lose their home.
It’s important to note that just because a mortgage is repaid, this doesn’t mean that someone is financially secure. Is income required above and beyond this to cover living costs? (see Family Income Benefit above).
Failure to provision for this could lead to having to sell the home anyway which would be against the very reason for taking the policy in the first place.
This type of policy is usually suitable for joint borrowers and/or people who have financial dependents.
It’s important to note that this policy is not usually suitable for single people who have no financial dependents (contrary to what some people may believe)
- Critical Illness Cover
Critical Illness Cover pays out in the event of more serious illnesses such as Heart Attack, Cancer and Stroke.
It’s usually set up to be taken as a lump sum, although can be taken out as a Family Income Benefit (see above).
Some people confuse Critical Illness with income protection and tend to ask what the difference is.
Aside of income protection being a regular monthly amount and Critical Illness usually being a lump sum, the clue is in the title.
Critical Illness will only pay out in the event of specified critical illnesses. Income Protection is designed to pay out in the event of being unable to work due to incapacity.
This means that income protection covers critical illnesses, but Critical Illness Cover doesn’t cover conditions that the policy doesn’t specify as critical.
This is why Income Protection should usually be seen as a priority over Critical Illness Cover.
So do you really need Critical Illness Cover if you have Income Protection?
Although there is some crossover, they do serve different purposes. In the event of suffering a Critical Illness, there may be further costs to cover. These could include the cost of private care, medicine or home alterations. This is where funds in addition to your income protection could be vital during a very difficult time.
For this purpose, you could set the amount of cover to 1-2 years of your annual earnings.
If your budget allows, you may also look to cover your mortgage balance in full so that there is less pressure to return to work. However, this is usually the most expensive form of cover and will only be available to those with the disposable income to cover it and after all other priorities have been covered.
This type of policy is usually of interest to anyone as this could happen to anyone.
- Accident, Sickness and Unemployment Insurance (AKA ASU)
ASU policies are short term policies that pay a monthly amount if you are unable to work due to accident, sickness or being made redundant.
They usually pay out for a maximum of up to 12 – 24 months and are reviewed on an annual basis.
For the accident and sickness element, people tend to opt for income protection for a number of reasons. For example,these could include the amount you can cover for, certainty of premiums and the length of time you can claim for.
However, for people who can’t access Income Protection, either because of being declined or because it’s too expensive, this type of cover has its place and should be seen as a priority if income protection isn’t available.
For the redundancy element, whether this is a priority will depend on each individual. For example, if you are younger with a broad skill set, you may think that finding alternative employment would not be a challenge if you were made redundant. On the other hand, if you are older in a very specialist role, you might feel that finding alternative employment if you are made redundant may be more of a challenge.
The important point with redundancy cover compared to the others, is that this one is based on your employer’s ability to run a company and sustain your role, not your ability to work based on your health.
If you are confident of finding another acceptable job in an acceptable time frame, it’s unlikely that this will be a priority for you, compared to the policies above, but should still be considered as there is a risk.
Some providers may allow you to separate the elements to this policy (for example, just accident and sickness cover or redundancy only cover).
This type of policy is usually of interest to anyone who relies on their earned income to fund their costs of living.
To summarise, it’s important to understand the financial risks involved when looking at how financially resilient you are.
If you identify any shortfalls and want to insure your financial security, it’s important to prioritise your cover in line with your individual circumstances and put a plan in place that is right for you.
