How Life Insurance Can Help You Buy a Home

Last Updated on August 9, 2022

| Posted on July 1, 2018

Every mortgage requires insurance because all lenders want to protect their investment. You'll pay for a wide range of products as part of your monthly payment: mortgage insurance, home insurance, and possibly even life insurance.

Even if not required, life insurance can help you secure the mortgage you need to buy your dream home.

Why do you need so many kinds of insurance and why do lenders demand life insurance for a home loan? Keep reading to find out.

Homeowners Insurance 101: What Is It?

Homeowners must insure their properties, but to what extent? You'll find three common types of insurance covering different parts of the home. Some lenders require these products while others only request them.

The three common insurance products are:

Hazard insurance
Private mortgage insurance
Life insurance

Do you recognize these products? Keep reading to find out.

Hazard Insurance

The industry term for the product is "hazard insurance," but it's most commonly known as homeowner's insurance.

Hazard insurance covers minor and major damage to your house. Storm damage, fire damage, and faulty plumbing may be covered by your policy depending on your state and coverage provider.

Lenders deny mortgages to buyers without hazard insurance. Evidence of an active policy is mandatory when you sign the paperwork for the loan.

Private Mortgage Insurance

Private mortgage insurance (PMI) covers the mortgage itself. Banks require it when homeowners put down less than 20 percent of the purchase price.

PMI isn't a punishment for a small downpayment. Rather, it makes low- and no-downpayment mortgages possible.

Life Insurance

Life insurance covers you. It's a policy that pays out a cash benefit after your death.

What does this have to do with your mortgage? Life insurance for home loans may help you buy the house of your dreams and protect you after the deal closes.

The Purpose of Payment Protection Insurance

Hazard insurance and private mortgage insurance protect your investment and the bank's investment. But the benefits are skewed more toward your lender. After all, you don't own the house until you pay off the mortgage and the accumulated interest.

Life insurance protects you and your family before and after the purchase of your new home. Some policies allow you to:

Borrow a downpayment
Cover your mortgage

Here's what life insurance might mean for you.

Borrow a Downpayment

Some life insurance policies allow policyholders to borrow from the cash accumulated over the term.

You can't borrow the whole benefit--only part of the present cash value.

It's possible to use the cash to help meet downpayment obligations on a mortgage. There's no credit check because it's not a traditional loan; you're borrowing money from your future self. It's also not taxable because the IRS doesn't count the money as income.

Borrowing a downpayment is often possible only when you've held the policy for several years. If your policy isn't valuable enough to withdraw cash, consider other sources.

Some people find their parents, grandparents, or another relative took out a life insurance policy when they were children. Those policies may hold enough value to withdraw some cash.

The same benefits would apply to policies in your name even if you didn't sign the dotted line. The income isn't taxable, and the money is removed from your future benefit.

Cover Your Mortgage

Your life insurance policy may keep working for you even after you collect the keys. How? Because life insurance serves as a critical lifeline for survivors in preventing foreclosure after the death of the primary borrower.

While hazard insurance covers your property and PMI covers your lender in the event of missed payments, a life insurance policy protects your family in the event the mortgage goes unpaid.

If the mortgage payer passes away and has a life insurance policy, the policy helps keep families left behind in their homes. The payout provides a lump sum or monthly payment to cover expenses in the event of the death of the policy owner.

Are There Strings Attached?

Withdrawing from a life insurance policy isn't like taking out a loan in several ways. No credit check is required--you're only borrowing from yourself.

Still, a life insurance policy isn't a savings account. Money borrowed isn't free and clear.

Most life insurance companies don't require you to pay back the loan against the cash value of your policy. Don't make the mistake of thinking there are no penalties.

Because the insurance company is missing out on investing and earning that money, it charges interest against your remaining cash value.

The interest eats away at your remaining death benefit and reduces what's paid out at the end of the term.

Additionally, the withdrawal is tax-free to a point. You won't pay tax on money withdrawn up to the dollar amount of premiums you've paid.

If you sent in $10,000 in premiums, you would receive $10,000 tax-free. Anything over that figure is taxable.

Finally, the tax-free benefit is only available when you withdraw during your life. Taxes come out of the benefit when the benefit is paid out after death. Taxes combined with interest could significantly reduce your death benefit if the policy isn't paid back.

Terms vary by provider and tax laws change regularly. Be sure to ask about interest rates before making the decision to withdraw.

What Life Insurance Can Help You Pay Your Mortgage?

Not all life insurance policies allow withdrawals. Typically, only permanent life insurance plans allow you to withdraw over the course of your life. Permanent policies cover you for the course of your life.

Your employer-based plan is unlikely to allow withdrawals. Many providers provide a term-based life insurance policy that covers you only during a set period, such as the period of employment with that company. A term plan only pays out if you die during that term, and thus, won't provide a loan.

Do You Need Home Life Insurance?

Life insurance can help you buy a home and keep your family there in case something happens to you. Still, withdrawing from a life insurance plan isn't free money: it will reduce your death benefit if not paid back.

Do you want peace of mind and a smaller down payment? Contact us today for a free life insurance quote.