The death of a spouse, partner or parent is an upsetting time for close family members.
Losses like these not only cause emotional upheaval, but can also translate into wider, financial concerns for the loved ones that are left behind. Especially, for example, if the person that’s died was also the household’s main breadwinner.
In the event of an untimely death, decreasing term life insurance can stabilise concerns by offering dependents a financial lifeline in times of need. Here’s how it works...
What is decreasing term life insurance?
Life insurance comes in various guises. Often referred to simply as ‘decreasing term’, this particular form of cover helps loved ones pay off commitments should an individual pass away still in debt to a particular financial product.
For example, decreasing term cover is often taken out to pay off the outstanding amount remaining on a standard repayment mortgage in the event of a borrower’s death. It can also be used to pay off other types of debts, such as car loans or credit card bills. Payouts are made tax-free.
How long is it needed?
The cover lasts for a set amount of time, known as the ‘term’. For a 25-year standard repayment mortgage, for example, the term of the insurance policy might run for the same length of time to match the home loan in question.
The idea is that the amount of cover that gets paid out reduces each year, therefore matching the mortgage’s outstanding debt profile. Eventually, this amount will fall to zero.
As an example, if you took out a £100,000 decreasing term policy over 25 years but died half-way through the course of the policy, the beneficiaries would receive £50,000.
In a fix
In return for offering decreasing term cover, an insurer receives a fixed monthly premium reflecting the overall cost of the policy from beginning to end. Note that the premium remains fixed, even though any payout made by the policy decreases over time.
But because of the way it works, decreasing term cover works out cheaper than an insurance policy where the amount of cover is specified to stay the same throughout the period of insurance - this is known as ‘level’ term.
Who takes out decreasing term insurance?
It’s usually most appropriate for those who want to cover a specific debt.
Mortgages tend to be many people’s largest financial obligation. In the event of your untimely demise, a pay-out from a decreasing term policy would enable loved ones from your household to clear the outstanding debt on a repayment mortgage and allow them to continue living in the property.
Before offering would-be borrowers a mortgage, some lenders insist that customers have the necessary life insurance in place to cover just such an eventuality.
You’re not obliged to accept a policy from the lender concerned, although a mortgage deal may fail to materialise without some form of life cover in place.
Not suitable for all
While decreasing term is a good match to pay off the outstanding amount from a repayment mortgage, the same doesn’t apply to customers with interest-only mortgages looking to achieve a similar level of financial security.
Interest-only home loans work in a different way to their repayment counterparts. As such, interest-only mortgage borrowers may be better advised to take out a different form of life cover, such as level term insurance, which pays out the same agreed amount regardless of timing.
Still unsure? Consult a broker
If you’re unsure which type of cover would most suit your circumstances, it’s worth contacting an independent insurance broker who can run through the options and help you find the most suitable cover.
When it comes to the cost of decreasing term cover, the premiums set by an insurer will depend on a number of factors. These include:
· Health and family medical history
· Amount of cover chosen
· Length of policy
The more an insurer thinks that you are likely to die during the term of a policy, then the higher the premiums on your policy will become. Someone taking out a policy in their twenties will find it cheaper than a 40-something looking to obtain the same level of cover.
If you search online for a decreasing term quote, it’s important that you provide accurate details about yourself. Not doing so could invalidate a policy should you go ahead and decide to take it out.
How long should the term be?
This will vary with personal circumstances, but there are a few variables worth factoring in.
For example, if the main consideration is ensuring that your loved ones can pay off the mortgage in the event of your death, then the term on the insurance policy needs to be as long as the one on the home loan.
Note that if you survive past the end of the term of a policy, there’s no maturity value to cash in and no way of recouping the premiums that you’ve already paid the insurer.
Pros and cons
When it comes to the advantages and disadvantages of decreasing term life insurance, it’s worth bearing in mind a few points.
For example, the premiums on these policies tend to be cheaper than they would be for level term insurance. That’s good news if money’s tight, but you’re still keen to protect your loved ones from financial concerns in the event of your premature death.
In terms of downsides, decreasing term cover is usually designed to pay a debt such as a mortgage. But the surviving family will have other financial commitments and ongoing living expenses. If money allows a level term policy, the sum insured can be set at a level which would cover the mortgage and leave additional funds to meet other costs and obligations.
It’s also important to understand that the amount your policy would pay out reduces over time, even though the size of your premiums remains the same. That might seem like relatively poor value if a claim is either never made, or only becomes necessary at the end of a policy’s term.
Outlive the term of the policy and there’s no maturity value to recoup from the plan, either. On the flip side, the fact that you haven’t claimed means you’re still alive. In the view of many families, that’s a price definitely worth paying.