Mortgage protection insurance vs. life insurance - what's the difference?

What’s the difference between life insurance and mortgage insurance?

If you want to protect yourself and your family financially if the unexpected happens, mortgage protection insurance and life insurance are two potential options. Most life insurance policies let your family access a lump sum if you pass away, while mortgage protection insurance can help cover the cost of your mortgage payments if you’re unable to work due to injury or illness.

Because of the differences between life insurance and mortgage protection insurance, it’s important to compare the available options and make an informed decision when choosing a policy.

What is life insurance?

Life insurance is a type of insurance policy designed to financially protect your loved ones if you pass away. In some cases, it might also apply if the insured person is diagnosed with a terminal illness and has a limited life expectancy.

In the event of a person’s death, a payout from a successful life insurance claim could be used to make home loan repayments or to pay off the loan entirely, depending on the level of cover. However, unlike a mortgage protection policy, most life insurance policies are not directly linked to a home loan.

How much does life insurance cost?

The cost of a life insurance policy is likely to depend on a number of factors specific to the person being insured, such as:

• Age
• Smoking status
• The amount of insurance required (e.g. whether the individual would need cover to pay off their mortgage)
• Occupation and hobbies
• Health and medical history
• Features and inclusions offered by the policy
• The provider you choose (it could be worth comparing multiple insurance providers)

How do I get life insurance?

Life insurance policies can be directly purchased from a life insurance provider, or arranged via a financial adviser. Plus, you may already have a level of cover through your superannuation.

While you may be able to get mortgage insurance when applying for your home loan, this is not normally also true for life insurance. However, some lenders also offer their own life insurance or sell it on behalf of another insurer, in which case you may be offered life insurance when you take out your home loan.

What is mortgage protection insurance?

Mortgage protection insurance (sometimes called mortgage repayment insurance) is an optional type of insurance specifically designed to cover home owners and their families from some risks that could affect their ability to pay back their home loan, such as:

• Involuntary job loss
• Injury or illness
• Death

How does mortgage protection insurance work?

If you’re unable to work for a period, a mortgage protection insurance policy may kick in and cover your repayments while you are not earning your usual income. If you pass away, the policy may pay out the balance of your home loan, or provide a specific lump sum stated in the policy, to help your loved ones repay the outstanding debt.

Given the fact that it can cover the policyholder if they are unable to work or if they pass away, mortgage protection insurance resembles both income protection insurance and life insurance. A key distinguishing factor is that mortgage protection insurance has coverage linked to home loan costs specifically, and will generally not cover any of the policyholder’s other expenses or living costs.

How much does mortgage protection insurance cost?

As with many kinds of insurance, the cost of a mortgage protection insurance policy is likely to depend largely on the policyholder’s circumstances and the item being insured – in this case, a home loan. Some considerations may include:

• The total home loan amount
• The regular home loan repayment amount
• Whether the policy is in one person’s name or covers multiple people (multi-policyholder discounts might apply)
• The age of the policyholder(s)
• The type of policy and any features included or excluded
• The insurance provider (again, it may be beneficial to shop around)

Is mortgage protection insurance cheaper than life insurance?

Mortgage protection insurance could be less expensive than a life insurance policy, as its cover is typically limited to expenses relating to repaying a home loan. However, this may not always be the case, so you should consider looking at the level of cover that applies and other relevant factors before committing to a particular type of insurance cover.

According to Moneysmart, an important question to consider is whether mortgage insurance premiums will be added to your loan amount. This could mean paying interest on these premiums, which could add considerably to the cover’s overall cost.

Is mortgage protection insurance worth it?

While mortgage protection insurance may be useful in some circumstances, it’s important to note that as a form of Consumer Credit Insurance (CCI), mortgage protection cover has come under heavy criticism in recent years. Following a review of this industry in 2019, the Australian Securities and Investments Commission (ASIC) found a number of issues affecting consumers, such as:

• CCI is “extremely poor value for money”. Across all CCI products sold by lenders, only 19 cents was recovered in claims for every premium dollar which consumers paid.
  
• CCI sales practices were harmful to consumers:
• consumers were sold CCI despite the fact they were ineligible to claim under their policy
• telephone sales staff used high-pressure selling and other unfair sales practices when selling CCI, and
• consumers were given non-compliant personal advice to buy unsuitable policies.

Consumers were incorrectly charged for CCI, including being charged ongoing CCI premiums even though they no longer had a loan. Many lenders did not have consumer-focused processes to help consumers in hardship make a claim under their CCI policy.

Other factors to consider with mortgage protection insurance include:

• There may be an upper limit on the amount that can be claimed on a policy (i.e. it may not cover the entire loan amount and payments may stop after a limited time).
• Waiting periods may apply, meaning the policyholder might not be able to make a claim or receive benefits within a certain amount of time of the policy being taken out or a claim being made.
• There may be conditions and exclusions, such as not being able to make a claim if you are self-employed or work part-time, have a pre-existing medical condition or are above a certain age.
• This kind of policy only provides cover for mortgage expenses, and would generally not cover the policyholder for other expenses that might arise if they become unable to work or if they pass away.
• It’s not the same as lender’s mortgage insurance.

Moneysmart advises that sales staff may sometimes “try to pressure you” into purchasing CCI like mortgage protection insurance, and that it’s worth thinking carefully about whether you need it before you commit to a policy. From 5 October 2021, salespeople can tell you about CCI when you apply for credit or a loan. But they must wait until four days after your credit or loan is approved before selling it to you, to give you time to consider if you need it.

How do I get mortgage protection insurance?

Lenders sometimes sell mortgage protection insurance policies to homeowners when they take out a mortgage, or they may be offered by separate insurers. That said, these policies are generally not as commonly sold in Australia as they used to be, and several major lenders have stopped offering them to new customers in recent years.

If you are considering taking out a mortgage protection policy, be sure to read the product disclosure statement carefully and check with the provider about any exclusions, waiting periods or other terms and conditions that might apply before proceeding. Bear in mind that you may not need mortgage protection insurance if you already have separate life and income protection cover, such as through your super fund. Seek independent financial advice if you need it.

Remember that if you have difficulty repaying your loan, other options may be available that could make an insurance policy unnecessary, such as using your lender’s financial hardship policy or speaking with a financial counsellor.

Key differences between mortgage protection insurance and life insurance

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Are there other insurance options for homeowners?

Income protection insurance

An income protection insurance policy can help cover costs like an individual’s mortgage repayments if they are unable to work, by providing an income stream that replaces part of the policyholder’s regular income.

It can cover individuals for a portion of their lost income, typically up to 90% of pre-tax wages for the first six months and up to 70% for a set period of time after six months, due to events such as:

• Involuntary job loss
• Sickness or injury
• Total or partial disablement (a lump sum amount may be paid out in these cases)

Like life insurance, income protection policies are not exclusively designed to cover home loan repayments, and their payouts may also be used to cover other expenses. However, like mortgage protection insurance, some income protection policies have a limited maximum time period during which a benefit will be paid, meaning they may not be a suitable option if you want cover that would pay off the entire balance of a home loan.

Like life insurance, income protection policies can typically be taken out either directly from an insurer or via a financial adviser.

Income protection policies typically vary in cost depending on the insured individual’s occupation, as well as risk factors like their age and smoking status. A policy’s benefits and inclusions, as well as the provider offering it, may also affect the cost.

Home and contents insurance

Home and contents insurance policies are designed to cover a physical property and its contents from damage and burglary. They can be taken out separately as standalone building-only or contents-only policies, or as a combined building and contents policy.

Unlike some other types of insurance policies, a home and contents insurance policy won’t cover you if you are unable to make your home loan repayments. However, a policy could be worth considering if you are keen to protect yourself from the financial costs of loss or damage to your home or possessions.