When helping people looking for life insurance coverage, one of the most common comments I get is, “I have a $500,000 mortgage, so I just want a policy with a $500,000 face value so my wife can pay off the mortgage if I die.” While I am a fan of protecting your family with any amount of life insurance, I’m not a fan of this approach to calculating how much the face value should be. $500,000 may not be enough for some families, but then in some cases, you might be able to get by with less.
Option 1 - My ideal plan for my clients has nothing to do with paying off their mortgage. Instead, what they need is enough insurance to replace their income for as long as they plan to work. For example, let’s say you make $60,000 per year and plan to retire in 20 years. My income replacement calculator says that if you were to die, your spouse would need approximately $740,000, which would pay your spouse 80% of your income for 20 years. This way he/she can continue to pay all the bills (not just the mortgage), should something happen to you.
While having a policy worth a $740,000 may provide fantastic coverage for your family, and it’s certainly more life insurance than 90% of Americans have, it may be unaffordable. Don’t panic. Your family may be able to get by with less.
Option 2 - Say your mortgage payment is $2,500 per month. Did you know your spouse could pay that $2,500 per month payment for more than 20 years with just a $350,000 face value? This strategy assumes that upon your death, your spouse invests the death benefit proceeds, which will earn a conservative 6%, and draw off of that money to pay down the mortgage over time, rather than apply the entire $350,000 to the mortgage balance immediately upon your death.
There are several advantages to this strategy. First, it’s cheaper. Secondly, twenty years down the line, the mortgage balance will be significantly lower, while the value of your home should have increased significantly. At that time, your spouse would have many options, including refinancing the mortgage to get cash out or lower the payments, or sell the house and use the equity from it to purchase a smaller one. The point is, if you can’t afford option 1, option 2 still buys your spouse time and gives them plenty of options down the line.
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