You wouldn’t go rock climbing without a safety rope, or ride a motorbike without a crash helmet, and neither should you take out a mortgage without a financial safety net. This may seem like a strange analogy, but when we put ourselves at risk of physical injury, we take steps to protect ourselves. But when we put ourselves at risk of financial injury, we often forget to ensure we are similarly protected.
Most people would probably not consider a mortgage to be a huge risk. After all it is about buying or extending a home, fulfiling an ambition and moving onto or up the property ladder. But there is a risk and that risk is spelled out in the much quoted warning that accompanies all mortgage material: ‘Your home is at risk if you do not keep up repayments on a mortgage, or any other loans secured on it.’
How many times have you read this warning? A hundred times? A thousand? Probably many more. It is probably so familiar perhaps it is often dismissed as just another item of legal small print which appears on all sales material relating to house purchases. But this is a warning that has to be taken seriously. Clients need to be made aware of what could happen if they can no longer meet monthly payments. They could lose their home ‘ it is as simple and as frightening as that.
But in these relatively prosperous times, it can be difficult to explain what could go wrong. The most obvious line of argument is that people fund their mortgages from their income, but if they were to lose their job, or have to take a long time off work due to sickness or disability, then the income would stop. Similarly, the death of the breadwinner could have a serious effect on the family finances. The mortgage payments would become difficult to keep up with and the family home would move into the risk zone.
Thinking the unthinkable
Protection products can remove this risk by ensuring that if the unthinkable happens ‘ and while most people think that it may be unlikely, it is unfortunately very possible ‘ money is available to either pay off the outstanding mortgage or at least to meet the monthly payment. And, of course, all the necessary day-to-day living expenses.
So what are the most common mortgage protection products available? Essentially there are five main types of product. The first is mortgage payment protection insurance (MPPI), which will provide an income to cover the monthly mortgage payment if the borrower cannot work due to sickness and accident or becomes involuntarily unemployed. MPPI is quite a basic product and borrowers usually pay a flat fee, for example £3.50 per £100 of cover. Claim payments are usually limited to just one or two years, and while MPPI does have its limitations, it does at least provide an essential safety net.
The second is life cover, which will pay off the outstanding balance of the mortgage if the borrower dies. This could be important because the last thing a bereaved person would wish to face at such a distressing time would be the possibility of their house being repossessed.
Lenders are no longer making it a requirement for borrowers to take out life assurance to cover their mortgage. This adds to problems of under- insurance. Many negative things have been written about endowment mortgages but, for all their faults, one advantage they did have was that life assurance was automatically included within the repayment vehicle.
The third is critical illness cover, which will pay off the outstanding balance of the mortgage if the borrower gets one of a list of illnesses. This is more relevant for single people because if they survive their illness, they will still have to pay off their mortgage. Critical illness is often combined with life cover to ensure the mortgage is paid off in either eventuality.
The fourth mortgage protection product is income protection. Similar to the accident and sickness aspect of MPPI it has one major advantage; it will pay its benefit over the whole term if the borrower becomes sick for the long term. For example, if the borrower became disabled and could not work one year into a 25-year term, then the mortgage payments would be protected for the next 24 years (assuming the disability continued and no recovery was made), whereas most MPPI plans would only pay for one or two years.
Whereas one year should be enough to provide financial breathing space to find another job after being made redundant, a one-year payment to someone who is long-term sick will not meet protection needs. So, a combination of income protection and unemployment-only MPPI, offers more comprehensive cover.
Finally, the most recent innovation is menu protection products. These are modern term assurances that allow clients to select from a menu of life, critical illness, income protection and unemployment cover.
With modern protection and mortgage products now available, should brokers still be advocating decreasing term cover? It depends on what type of mortgage is being sold. Traditional repayment mortgages are being replaced by the flexible mortgage where capital and interest is paid each month.
The flexible mortgage allows the borrower to sometimes overpay for a month or drawdown further funds at a later date. Newer mortgage propositions allow the customer to combine their savings into the same account as their debt, so that any credit on the savings side can reduce the amount of interest payable on the outstanding loan.
So if the outstanding mortgage debt can change frequently, the traditional, mortgage term assurance solution that decreases at the same rate as the mortgage was traditionally repaid is no longer as viable ‘ even though protection is still as important. In this case, something like a menu product may be more suitable. Menu products allow cover to be increased, decreased or kept level according to the balance remaining within the flexible mortgage. Clients can reduce the cover if they pay off a chunk of the mortgage or could increase the cover if they borrow more.
An example of how this might work would be a client with a mortgage of £100,000. If they paid off £15,000 early then the life and critical illness cover could be reduced to £85,000 to compensate. If the clients were offsetting their savings against their mortgage and this reduced their monthly repayments down to £350, then again the monthly income protection and unemployment benefit amounts could also be changed.
The next step
It is all well and good to understand the benefits of mortgage protection, but selling it successfully is the most important step to grasp. Most consumers find protection boring and complicated so it can be difficult to encourage them to take out the full range of protection they need. Brokers may be reluctant to lengthen the process by introducing more concepts that need to be explained and forms that need to be filled in. A good way of reinforcing the concept of comprehensive mortgage protection is to compare it to car insurance. Nobody ever takes out the legal minimum of third-party only. Few people would even consider third party, fire and theft and most would go for fully comprehensive. MPPI benefit is more like third party, fire and theft, but what clients should consider is fully comprehensive cover.
To make it easier for the client to understand what this means it can be useful to get away from the jargon. Explain how it breaks down in its simplest form:
l For fully comprehensive mortgage protection certificate on a mortgage of £100,000. It can be arranged for your mortgage to be paid off if you die, or if you get a life threatening illness.
l It can also be arranged for your monthly mortgage payments to be paid if you cannot work due to sickness or unemployment.
However, all this cover might prove quite expensive for the client. One way to reinforce the importance of fully comprehensive cover is to start the discussions at this level, rather than starting with MPPI or life cover and then adding the other benefits during the course of the conversation.
While the client may not be able to afford this much protection initially, modern flexible products can be upgraded later on to include benefits missed off at the start.
The advantage of beginning discussions at the complete package level is that the client understands this is the optimum protection package for a mortgage and it can either be set up immediately or when they can afford it in future. The advantage for the intermediary is that it provides the foundation for a long-term relationship with the client.
Another technique to try may be to use interest rates to illustrate the price of protection. Seeing separate protection insurance premiums can put clients off taking them out. One way to overcome this is to combine the monthly mortgage payment and the protection premiums together into a one off ‘fully protected’ mortgage payment. This could even be expressed as an addition to the interest rate. For example, the standard monthly payment is based upon an interest rate of 6%. The fully protected mortgage is available for a small increase equivalent to 6.5%.
With the housing market booming and interest rates at an all time low, more people are buying houses and, depending upon where they live in the UK, are paying ever-higher prices and committing themselves to larger mortgages. Their homes are at risk if something goes wrong and they need to be protected. Intermediaries have to ensure their clients are fully protected.
But the market for mortgage protection is massive and getting your clients fully covered also means your own business will grow as a result.
Roger Edwards is director of products at Scottish Life New Protection Business
MPPI, life cover, critical illness and protection can all be used to protect a mortgage
Menu-based protection is flexible and cover can be adjusted to fit around the borrower’s outstanding debt..
Bolting the protection premium onto the cost of the repayment may encourage clients to take cover ‘ separate premiums can out people off.