Don’t consider reducing term insurance for interest only mortgages
There are many different forms of life insurance and many different types of mortgage, and sometimes it can be too easy for advisors, financial writers and even friends and families to simplify a statement, which can then cause confusion further down the line.
One of those statements often banded around is that reducing term life insurance is ideal for customers looking to protect their mortgages. For repayment mortgages which see the balance owed to repay the mortgage reduce over time then a reducing term life insurance policy, which sees the amount paid out to the customer reduce over time, is a great life insurance option.
It’s not the case for all mortgages however. Interest only mortgages were very common twenty years ago when a lot of advisors sold interest only mortgages alongside another financial product. The interest only mortgage was designed to allow the customer to keep their home, just paying interest to the lender for the money they had borrowed, whilst the other product was designed to grow in value and to be big enough at the end of the mortgage to allow the customer to pay off the entire balance of the house.
Interest only mortgages still exist on the market, although to a much lesser extent, and are not suitable with reducing term life insurance products. If a customer was to die a year into a £100,000 interest only mortgage, and they had a reducing term life insurance policy which paid out £100,000 initially, which then reduced down to nothing over the 25 years, the customer would leave around £100,000 to pay off their mortgage. If they were to die halfway through the policy, they’d only leave enough to pay off half the mortgage and if they died near the end they’d leave practically nothing, yet the outstanding mortgage balance would still be £100,000.
If you do have an interest only mortgage and you are looking for life insurance to protect your mortgage then you should consider fixed life insurance, which pays out a fixed amount, no matter how far into the policy you die, if at all.