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Life Insurance: Individually Owned vs Banked Owned
Question. My husband and I have recently purchased our first home together. Actually, we’re just in the final stages of the process, and wondering about insurance. The mortgage representative at our bank said we should buy our insurance at the bank because it’s made specifically for this purpose. Actually, she told us that mortgage insurance is mandatory for us. Is it? What exactly do we need here, and what type of insurance should we buy?
Answer. Great question, this is a very important decision with potentially life-altering consequences. However, before we dig into specifics, let’s clarify a few points. There appears to be a lot of confusion around the topic of mortgage insurance and life insurance. These are two entirely different things, let’s first clarify what we’re talking about.
When you peel back most of the fancy terminology and features, a mortgage is simply a loan. Mortgage insurance offers protection to the bank (or other institution) in the event that you can’t make your payments. To clarify, mortgage insurance protects the bank – not you. (Yet, you may be the one paying for it.)
Of course, not everyone is required to buy mortgage insurance. If you make a down payment of 20% or more, mortgage insurance is not required. On the other hand, a high ratio mortgage is defined as one where your down payment is less than 20% of the purchase price of the house. In Canada, most banks and lending institutions require mortgage insurance for high ratio mortgages. That is, if you make a down payment of less than 20%, you are typically required to buy mortgage insurance.
Although there are several mortgage insurance providers, the biggest player in the mortgage insurance market is the Canada Mortgage and Housing Corporation (CMHC). To find out how much mortgage insurance will cost, the CMHC has a mortgage calculator available on their website.
For example, at the time of writing, the current average house price in Canada is $487,000. With a down payment of 5%, which is $24,350, your mortgage insurance would cost a whopping $18,506.
Clearly, the cost of mortgage insurance is substantial. But the main point here is that mortgage insurance protects the bank, not you. It does not protect you in the event that you or your spouse dies prematurely, or incurs financial hardship. For that, you need life insurance.
The basic purpose of life insurance is to offer protection in the event of death. Life insurance is a contract between an insurance company and an individual (or possible more than one individual) known as the “life insured”. If the individual dies while the policy is in force, the insurance company pays an amount, known as the death benefit, to the beneficiary specified on the policy. In Canada, life insurance benefits are paid tax-free, regardless of the type of life insurance policy.
There are many valid reasons why someone may require life insurance. However, for young adults in particular, two of the most common scenarios triggering the need for life insurance are the purchase of a house, or the birth of a child. In both of these cases, the death of one spouse would typically lead to very significant financial hardship for the surviving spouse. Life insurance addresses this risk.
But not all life insurance is created equal, and there are some very important differences between an individually owned life insurance policy and the type the bank offers to you with your mortgage.
Top 3 Problems with Bank-owned Life Insurance
Unlicensed staff and no advice. Unlike licensed life insurance agents, bank staff and “mortgage specialists” who sell mortgage life insurance are unlicensed, and rarely have insurance training. Bank staff typically are not qualified to explain the details and legalities of insurance products.
This may not sound like a critical issue, but ensuring you and your family are properly protected is imperative. Life insurance can help mitigate the financial strain on your family and your loved ones in the event of your death. With an individually owned life insurance policy, your beneficiary can use the proceeds to help replace lost income, pay outstanding debt such as mortgage or credit cards, pay for your children’s education, and address other important financial needs.
Unfortunately, many families found out after the fact that they didn’t have the right type of insurance, or an adequate amount of insurance. Don’t let it happen to you.
Post-claim underwriting. Let’s unpack this term. Post-claim means that the underwriting happens afterthe claim. That is, it’s only after a claim is made (after death) is it determined whether or not you actually qualified for insurance in the first place. You may very well indeed be paying for insurance you don’t actually have. This is not exactly the peace of mind most families desire.
Several years ago, CBC Marketplace ran an episode title “Mortgage Insurance: In Denial” highlighting the severe risks present with bank-owned life insurance.
Quite unbelievably, banks can issue insurance to you, but then deny the coverage years later. Believe it. Many Canadians pay premiums thinking they are covered, only to find out – when it’s too late – that they actually never had insurance in the first place.
Lack of Control. With an individually owned life insurance policy, you are the policy owner. You decide the amount of insurance. You decide who the beneficiary is. Your beneficiary decides how to spend the insurance proceeds – pay off the mortgage, help fund education costs for your children, etc.
With bank-owned life insurance tied to your mortgage, you are not the policy owner. You have no control over the insurance proceeds – it pays the mortgage and that’s it. You can’t name a beneficiary – the bank is the beneficiary.
Life Insurance – Individually Owned vs. Bank-Owned
An individual policy is not only cheaper, but is superior to a bank-owned policy in virtually every aspect. The following is a summary of some of the key differences between individually owned and bank-owned life insurance plans:
Individual Insurance PolicyBank-Owned Insurance Policy
Death Benefit TypeNever changes – remains constant during the lifetime of the policyDecreases with every mortgage payment
Amount of Coverage Your choice – you can purchase as much or as little life insurance as you want No choice – Coverage matches mortgage amount owing and decreases as debt is paid. Your premiums do not decrease accordingly
Term Your choice – typically 5, 10 or 20 year terms are available, often with the option of converting to permanent insurance at any timeNo choice – your coverage is cancelled when the mortgage is paid or moved to another lending institution.
Beneficiary – Who gets the money if you die?Your choice – Anyone you wantNo choice – The bank
How the insurance proceeds are used in the event of deathYour choice – Life insurance proceeds are paid as tax-free cash, and your beneficiary can spend, save, or invest the money any way they chooseNo choice – Insurance proceeds are paid directly to the bank
Other uses for your policyYour choice – you can use the same policy to cover your general life insurance needs like paying off outstanding debts or funding your children’s education plansNone – Only the current mortgage amount is covered
Premium payments Your choice – Most insurance companies offer monthly, quarterly or annual payment schedules No choice – Insurance premiums are added to your mortgage payment
Premium discounts - Premium is affected by gender, age and smoking statusPremiums usually the same for all clients of same age
Portability Yes – Your insurance is not linked to the mortgage in any way. It stays with you regardless of where you live, work, move, or where you obtain or renew your mortgageNone – Your insurance can be cancelled if you renew your mortgage with a new lender, or even if you refinance at the same institution
Professional adviceYes – Personalized service from a licensed life insurance advisor to address your financial security needsTypical advice is limited to the mortgage insurance product only
Regulated salesYes – Only licensed life insurance agents can sell individual life insurance policiesNo – Retail bank staff and mortgage representatives are not required to meet life insurance license or education requirements
In most cases, bank-owned life insurance offers less coverage and more expensive than a personally owned plan. That is, you end up paying more, for less. More importantly, bank-owned life insurance can leave you and your family exposed to significant risks that could threaten your family’s financial well-being.