'Your home is at risk if you do not keep up the repayments on your mortgage or any other loan secure...
'Your home is at risk if you do not keep up the repayments on your mortgage or any other loan secured on it.' Appearing on all types of mortgage-related literature and advertising, this is a warning we have all become familiar with. But how many borrowers really consider the prospect of losing their home and therefore look to protect it?
According to research conducted by Dataquest in 1995, the two biggest fears for consumers are losing their home and losing their job. With over 33,000 repossessions occurring in 1998, this is a very tangible fear. Reductions in benefits mean that we can no longer rely on the State to bail us out if our homes are in danger. State mortgage benefits are means tested and, according to the DSS, 70% of applicants applying for income support will fail to qualify. Those that do qualify will not receive any benefits for 39 weeks. Increasingly, therefore, our homes can only be protected by self-funded insurance.
In most cases it is a condition of the mortgage to have sufficient life cover in place. This may provide cover in the event of death, but what happens if a person suffers a heart attack and cannot return to work? Critical illness cover would address this need, but what if they have a bad back or suffer from depression, two of the main causes of workplace absence?
Unlike life and critical illness cover, mortgage payment protection insurance (MPPI) - also known as accident, sickness and unemployment - will pay out for illness or if a person loses their job. While it will not pay off the total loan, it will cover the mortgage commitment until a return to work. It sounds comprehensive, until you discover that benefits are only paid for one or two years at most.
With so many products available, each protecting a different need, without a crystal ball it is difficult to decide which to buy. However, mortgage income protection (MIP), the newest product line in the mortgage protection sector, is aiming to remove this dilemma by offering borrowers more relevant and comprehensive mortgage cover.
Currently only written by a handful of providers, MIP works in a similar way to standard income protection, where applicants are underwritten according to age, sex, occupation and salary. On claiming, they receive a monthly benefit, with the only difference being that the benefit is designed to match the mortgage commitment rather than a proportion of earnings.
If the plans are so similar, why is there a need for two distinct policies? If it is only to protect a mortgage then surely a lower proportion of salary can be insured on a conventional income protection plan.
Calculations
The reason lies in the way that MIP benefits are calculated, according to Richard Verdin, marketing manager of housing markets at Legal & General. By tracking the Halifax standard variable rate, the company's Mortgage Payment Insurance guarantees the benefit will meet the mortgage commitment irrespective of rate changes. Verdin says: "The contract reflects the constant change in the cost of the loan and it is this that allows us to price the product so competitively."
If interest rates fall the benefits will reduce accordingly, but if rates rise the borrower can be sure repayments will be met. The plan has the added advantage that policyholders can gear up to 140% of the mortgage to cover bills and other monthly expenditures. However, it can only be bought as a rider to life cover.
Guardian Financial Services (GFS) offers a similar mortgage income protection plan and, like the L&G plan, it guarantees to meet the policyholder's monthly capital and interest repayments.
A spokesperson for GFS says: "Although interest rates are currently low it is possible that over the term of a 25-year mortgage they could increase. If this were to happen the plan provides the customer with a safety net that traditional income protection cannot."
Zurich Life's Comprehensive Mortgage Insurance works in a slightly different way. Instead of tracking mortgage rates, the Zurich plan pays 1% per month of the initial sum assured, so while it does not guarantee to meet the policyholder's mortgage commitment, the company is confident that this fixed sum includes sufficient cushioning to meet higher repayments should rates continue to rise. To ensure every eventuality is covered without duplicating cover already in place, clients can design their own plan to include life and critical illness cover, as well as income protection.
Unemployment, however, is still a big concern for many people and it is for this reason the providers mentioned above all allow unemployment cover to be purchased as a rider to the MIP insurance, so as to ensure mortgage payments are met should the homeowner become involuntarily unemployed. As with MPPI, however, cover is only temporary, usually paying out for a maximum of 12 months.
Client objections
While MIP is more comprehensive than its predecessors, cost will always be an objection that the IFA has to tackle, particularly with first time buyers. First time buyers tend to stretch themselves to the limit to buy, and what is left after the deposit, legal costs and other fees that need to be paid is likely to be earmarked for things such as furniture and decorating. Few will think to set something aside to protect their mortgage.
John Ravenscroft, former protection market director at Zurich IFA Group, thinks the lender should play a part in encouraging borrowers to protect their mortgage, making it an integral part of the sales process.
"When the lender is deciding how much to lend they should be taking into account the cost of mortgage protection," Ravenscroft says. Borrowers who cannot afford to buy cover should be encouraged, he suggests, to reduce their mortgage to ensure they can afford to protect their investment.
"It is better to live in a £90,000 house that is protected than a £100,000 house that you may lose in 12 months time if you are sick."
Clients who opt for the more expensive house and decide not to buy protection, however, should not be neglected. When borrowers are stretched to their limits there are marvellous opportunities for IFAs to follow up a year later.
Verdin says cost should not be as huge an obstacle when expressed as a percentage of the total mortgage debt.
He says: "A 25-year-old clerical worker, for example, taking out cover for a £50,000 mortgage, earning £20,000 a year protecting a £400 monthly mortgage payment with a 13-week deferred period, could expect to pay just 0.2% of the loan." This, he says, is a small premium to pay considering mortgage rates have fallen by 8.45% since 1990.
While sales of mortgage protection have historically been poor, providers now believe that the prerequisites for growth are there. Verdin says that an increasing number of IFAs are finding that as mortgages have become more affordable, borrowers are more inclined to spend money on protection and we will see a substantial increase in penetration of the product.
"The customer now has more money and more awareness of the need to protect their homes. On top of this they have a greater confidence in products that are more relevant to their needs."
He adds that the incorporation of a mortgage protection recommendation in the Mortgage Code is another positive note. Once the borrower is aware that the IFA will raise the subject of mortgage protection, they are likely to view the product in a different light and are more inclined to think the IFA is helping them, rather than selling to them.
"Customers have historically seen add-ons as a sales opportunity, but they are now placing more importance on the product," says Verdin. This is particularly the case for second time buyers in their mid-30s who have witnessed the impact of sickness and disability on income in friends and relatives.
Sales of critical illness insurance soared when it associated itself with the mortgage market. Over two-thirds of critical illness policies are now sold to protect a mortgage, according to ERC Frankona. If income protection could do the same we could see an increasing number of borrowers protecting their homes.
There is a natural fit between income protection and the mortgage market as there is a need for people to protect their mortgage in the event of long-term sickness. The State cannot and will not provide a safety net, therefore it is down to the individual mortgagee to protect themselves and their assets.
Rachel Williams is senior staff writer
