The mortgage market has changed significantly in recent years – the number of first-time buyers has fallen, remortgages have increased dramatically and the buy-to-let market has taken off. Mortgages themselves have changed – interest is now generally calculated daily and most new mortgages have an element of payment flexibility.
Where once there was a simple choice between fixed or variable rate, the range now includes 25-year fixed rates, two-year discounted rates, Bank of England base rate trackers, stepped trackers, capped rates and offset mortgages.
Each of these different types of mortgages has different levels of flexibility depending on the lender. Typical options range from no early repayment charges, to the ability to take payment holidays, through to allowing the borrower to extend the size of the loan.
All this flexibility poses the question of what type of life cover should we sell to protect the mortgage. Although decreasing cover has historically been the cheapest way to protect a mortgage, there is a strong argument that level cover is now the better option.
Because with decreasing cover the sum assured decreases over time roughly in line with the capital outstanding on the mortgage, the premium is lower than a level term assurance. When the types of mortgages people bought were limited and the outstanding mortgage was likely to reduce over time in a predictable way these products were fine. But can the same be argued today?
Some decreasing term products guarantee to pay the outstanding value of the mortgage provided three or four conditions are not broken. Typically the guarantee applies if the mortgage is on a repayment basis, payments are up to date and there has been no term extension or increase in the loan amount.
Where the guarantee does not apply, or the guarantee conditions have been broken, a single interest rate is used to calculate the policy sum assured on a given date regardless of the mortgage product bought. The rate varies between providers. If a higher interest rate is used, it provides more potential cover but the premiums are likely to be more expensive.
These approaches both have disadvantages with today’s more flexible mortgages. Even where a guarantee exists is it realistic that over a 25-year term those conditions will be met? With the current remortgaging boom, the desire to move up the property ladder and the flexibility of today’s mortgages, there is a possibility that the mortgage will break one of the conditions imposed.
None of these complications arise with level term assurance, and because extra protection develops over the course of the mortgage, the product can potentially cope with increases in the mortgage amount. And when clients remortgage we know exactly the amount of cover they have and can therefore easily calculate any additional protection they might need.
With the growing flexibility of mortgages, particularly the ability to increase the amount borrowed or take payment holidays, coupled with much more remortgage activity to obtain better repayment rates or release equity, the decreasing term assurance might not fit with modern mortgages.
Level term assurance is not that much more expensive. Typically the price gap is around 20-30%. Transferring from decreasing to level cover would benefit the client and the adviser, as clients know the exact amount of cover they have and this gives them added security as and when they utilise the flexibility of the mortgage. For the adviser, calculating clients’ future protection needs for family and mortgage protection becomes easier.
Finally, buying a level term assurance could mean there is some money left over should a claim need to be made, providing some valuable extra protection when it is needed most.