What is Decreasing Term Life Insurance?
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UPDATED: Oct 8, 2011
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It is almost impossible to buy a house or other large item these days without applying for credit. Prices are so high that few are able to save the full amount of a large purchase before needing the item, so many people finance their purchases with mortgages or credit terms. This makes it easy for people to pay for larger items in installments.
However, what would happen to your family if you died and your mortgage remained unpaid?
There is a type of life insurance that is available to protect your heirs if something happens to you and you leave a large amount of debt behind. This type of coverage is known as decreasing term life insurance.
Sounds good but how does it work?
Decreasing term life insurance is a special type of term life insurance that decreases in face value the longer you pay for it. While this may seem contradictory, the rates are so low that most people are willing to give up any cash value in the policy for the protection it offers.
What a decreasing term policy does is protect your debt until you are able to pay it off. For example, if you purchase a house for $350,000 on a 30-year mortgage, you may be offered decreasing term insurance of 30 years with an initial face value of $350,000. As you pay your mortgage over the course of 30 years, the principal amount will decrease gradually, and finally disappear. As your principal decreases, the face value of your insurance similarly decreases, and when your mortgage is paid off, your decreasing term life value is zero. However, if you die while paying your mortgage, your decreasing term life will pay off the principal balance of your mortgage, no matter what the amount.
How much is decreasing term life insurance?
Most decreasing term life policies offer very low premiums, and for this reason many people find them an attractive option, especially if they have a very large mortgage. By purchasing this cheap life insurance, they are able to protect their family from trying to find a way to pay for the family home, and any other life insurance proceeds can be used for expenses.
Decreasing term life is not only applied to mortgages. Many credit card and personal loan companies also offer decreasing term life coverage for their products. The structure of these insurance policies is a bit different, as your principal balance may vary from month to month. Most of these policies calculate your rates based on your monthly principal balance as a percentage, and charge the premium directly to your account. If you have a monthly balance of zero, you are not charged anything for the coverage. If something happens to you and you are unable to work, some policies also offer a disability clause which will make your minimum monthly payments until you are able to return to work. Of course, if you die, the insurance is required to pay your balance in full.
What are some disadvantages to decreasing term life insurance?
There are disadvantages to decreasing term life, of course. If you have no heirs or others to worry about leaving your estate to, then it makes little sense to insure your debt, as the company will simply retake your collateral when you die and sell it to someone else to recover their investment. Even if you do have heirs, in many states life insurance companies are limited in the amounts they can recover from family members after the death of a provider. In some states, foreclosure of a house is illegal if the “widow and orphans” use the home as a primary residence. In order to see if you really need decreasing term life, you should review the laws applicable in your state or talk to an attorney about the situation.
Another disadvantage to the decreasing term life concept is that you are not really paying for any benefits, as you would if you took out a regular term policy. Your heirs will receive no cash; your bills will simply be paid. A far more feasible financial plan is to pay off your credit cards yourself and use the money you save to take out a policy which will provide some cash benefit to your survivors. Of course, not everyone is able to do this, but it can be a goal for any family and often prevents messy financial problems.
Many people also feel that decreasing term insurance is not good value for your money, and it is better to take out a slightly higher-cost term policy which will be designated to pay off your mortgage. In this scenario, you may pay more for your coverage, but if you die toward the end of your mortgage term, your survivors will have a lump sum payment which, after paying the mortgage balance, can be used for any other expenses.
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