Income protection vs. mortgage insurance: What you need to know

Income protection vs. mortgage insurance: What you need to know

Both income protection insurance and mortgage protection insurance are income replacement products with different types of coverage. The most significant difference is that you can only use mortgage protection to cover your mortgage repayments if you’re unable to earn an income.

On the other hand, you can use income protection insurance to cover your living expenses for the benefit period or the period you’re receiving the payment. These expenses can include your mortgage repayments, depending on the plan you are on.

What is the benefit of taking out income protection insurance?

People often underestimate the risk of not being able to work due to an illness or disability. According to a survey by global insurer Zurich, twenty-nine per cent of Australia’s working population would survive less than a month without their income. Sixty-five per cent believe their savings would not last more than six months if they stopped earning. 

Having income protection insurance provides you with an alternative income source when you cannot work due to unforeseen circumstances. However, the survey also found Australians to be the least willing to spend on insurance protection. This lack of interest is despite the fact cover is often available for less than five per cent of their earnings, depending on factors like age and the extent of cover required.

When it comes to the benefits, an income protection policy pays up to seventy-five per cent of your pre-tax income during the benefit period. You can use this amount to meet your daily expenses and pay your bills in the absence of any earnings due to an accident or sickness.

For instance, if you get COVID-19 and have to take time off work to receive treatment. If you don’t have sick leave or enough sick leave, you can make a claim on your income protection policy to pay for your living expenses for that period.

Who needs income protection insurance?

Most people can benefit from having an income protection cover in place. But it’s even more important if:

  • You have a home loan or other debts that you need to repay, even if you’re working or not.
  • You’re the sole income earner in the family and have dependents who rely on the income you earn.
  • You don’t get any sick days or annual leave from your employer because you’re self-employed, work as a freelancer or work casually. 

Income protection insurance vs. mortgage protection insurance

Mortgage protection insurance cover helps you repay your mortgage if you suddenly lose your job due to an illness or injury. It also covers your mortgage repayments if you die so that your family home is protected even after you’ve passed. 

The fundamental difference between income protection insurance and mortgage protection insurance is that mortgage protection only covers your mortgage repayments. Whilst income protection also takes care of your other bills like school fees, credit card payments, etc.

The other big difference is that you may compare income protection insurance plans from various insurers before choosing the right cover for yourself. However, with mortgage protection insurance, you’ll likely take this out with your home loan provider. 

Taking out mortgage protection insurance is not a mandatory requirement for many home loans. It’s often good to have, just in case, if you don’t have any other insurance policy with similar benefits. However, if you’ve already got income protection, it’s worth looking at that policy before taking out a separate mortgage protection policy. Specifically, you should check if your current plan already covers your mortgage repayments. 

Should I choose income protection or mortgage protection?

If you’re a homeowner or planning to buy a property soon, you may be looking into the life insurance products available to protect your income and assets, especially your home. Some of the popular options are term-life insurance, disability insurance and income protection insurance. You may even consider mortgage protection insurance from your lender that explicitly covers your home loan repayments in the case of an unforeseen event like illness or death.

There’s no clear answer to whether income protection or mortgage protection is a better option. Your choice will depend on your personal circumstances, and no two situations are the same. However, if you’re looking to compare income protection, life insurance and mortgage protection covers. In that case, you’ll find that income protection typically provides better risk protection against financial hardships, including mortgage protection. Consequently, income protection is often the preferred choice for individuals who have other expenses besides a mortgage. 

If you’ve decided to go with income protection insurance, it helps to compare deals from various insurers to get the best possible price and policy. You could also seek help from an insurance broker to pick a policy that caters to your financial circumstances and goals.

The following tips can also help you to make an informed choice:

  • Ensure that your insurance provides you with an adequate cover that pays your loan repayments in case of unemployment while offering additional financial support.
  • Your policy benefit period generally starts after a waiting period of up to 120 days. If you’re rendered unemployed during this period, you’re ineligible to make any claim on your policy. If you wish to minimise this risk, you may consider a policy with a shorter waiting period, but it might cost you more.
  • The benefit period for income protection is variable. It can be a set period of, for instance, two years, or you can choose to set it with an end age, like 70-years old. Not all insurers offer both options.
  • If you’re confused between stepped and level premiums, the latter might turn out to be more cost-effective if you plan to hold on to the policy in the long run. Stepped premiums typically start cheaper but rise as you get older. On the other hand, level premiums might seem expensive at the outset but, the amount you pay tends to remain the same throughout the policy period. 

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Fact Checked -

This article was reviewed by Personal Finance Editor Jodie Humphries before it was published as part of RateCity's Fact Check process.

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Learn more about home loans

Cash or mortgage – which is more suitable to buy an investment property?

Deciding whether to buy an investment property with cash or a mortgage is a matter or personal choice and will often depend on your financial situation. Using cash may seem logical if you have the money in reserve and it can allow you to later use the equity in your home. However, there may be other factors to think about, such as whether there are other debts to pay down and whether it will tie up all of your spare cash. Again, it’s a personal choice and may be worth seeking personal advice.

A mortgage is a popular option for people who don’t have enough cash in the bank to pay for an investment property. Sometimes when you take out a mortgage you can offset your loan interest against the rental income you may earn. The rental income can also help to pay down the loan.

What are the features of home loans for expats from Westpac?

If you’re an Australian citizen living and working abroad, you can borrow to buy a property in Australia. With a Westpac non-resident home loan, you can borrow up to 80 per cent of the property value to purchase a property whilst living overseas. The minimum loan amount for these loans is $25,000, with a maximum loan term of 30 years.

The interest rates and other fees for Westpac non-resident home loans are the same as regular home loans offered to borrowers living in Australia. You’ll have to submit proof of income, six-month bank statements, an employment letter, and your last two payslips. You may also be required to submit a copy of your passport and visa that shows you’re allowed to live and work abroad.

When does Commonwealth Bank charge an early exit fee?

When you take out a fixed interest home loan with the Commonwealth Bank, you’re able to lock the interest for a particular period. If the rates change during this period, your repayments remain unchanged. If you break the loan during the fixed interest period, you’ll have to pay the Commonwealth Bank home loan early exit fee and an administrative fee.

The Early Repayment Adjustment (ERA) and Administrative fees are applicable in the following instances:

  • If you switch your loan from fixed interest to variable rate
  • When you apply for a top-up home loan
  • If you repay over and above the annual threshold limit, which is $10,000 per year during the fixed interest period
  • When you prepay the entire outstanding loan balance before the end of the fixed interest duration.

The fee calculation depends on the interest rates, the amount you’ve repaid and the loan size. You can contact the lender to understand more about what you may have to pay. 

Why does Westpac charge an early termination fee for home loans?

The Westpac home loan early termination fee or break cost is applicable if you have a fixed rate home loan and repay part of or the whole outstanding amount before the fixed period ends. If you’re switching between products before the fixed period ends, you’ll pay a switching break cost and an administrative fee. 

The Westpac home loan early termination fee may not apply if you repay an amount below the prepayment threshold. The prepayment threshold is the amount Westpac allows you to repay during the fixed period outside your regular repayments.

Westpac charges this fee because when you take out a home loan, the bank borrows the funds with wholesale rates available to banks and lenders. Westpac will then work out your interest rate based on you making regular repayments for a fixed period. If you repay before this period ends, the lender may incur a loss if there is any change in the wholesale rate of interest.

What is mortgage stress?

Mortgage stress is when you don’t have enough income to comfortably meet your monthly mortgage repayments and maintain your lifestyle. Many experts believe that mortgage stress starts when you are spending 30 per cent or more of your pre-tax income on mortgage repayments.

Mortgage stress can lead to people defaulting on their loans which can have serious long term repercussions.

The best way to avoid mortgage stress is to include at least a 2 – 3 per cent buffer in your estimated monthly repayments. If you could still make your monthly repayments comfortably at a rate of up to 8 or 9 per cent then you should be in good position to meet your obligations. If you think that a rate rise would leave you at a risk of defaulting on your loan, consider borrowing less money.

If you do find yourself in mortgage stress, talk to your bank about ways to potentially reduce your mortgage burden. Contacting a financial counsellor can also be a good idea. You can locate a free counselling service in your state by calling the national hotline: 1800 007 007 or visiting www.financialcounsellingaustralia.org.au.

What percentage of income should my mortgage repayments be?

As a general rule, mortgage repayments should be less than 30 per cent of your pre-tax income to avoid falling into mortgage stress. When mortgage repayments exceed this amount it becomes hard to budget for other living expenses and your lifestyle quality may be diminished.

What happens to your mortgage when you die?

There is no hard and fast answer to what will happen to your mortgage when you die as it is largely dependent on what you have set out in your mortgage agreement, your will (if you have one), other assets you may have and if you have insurance. If you have co-signed the mortgage with another person that person will become responsible for the remaining debt when you die.

If the mortgage is in your name only the house will be sold by the bank to cover the remaining debt and your nominated air will receive the remaining sum if there is a difference. If there is a turn in the market and the sale of your house won’t cover the remaining debt the case may go to court and the difference may have to be covered by the sale of other assets.  

If you have a life insurance policy your family may be able to use some of the lump sum payment from this to pay down the remaining mortgage debt. Alternatively, your lender may provide some form of mortgage protection that could assist your family in making repayments following your passing.

What is Lender's Mortgage Insurance (LMI)

Lender’s Mortgage Insurance (LMI) is an insurance policy, which protects your bank if you default on the loan (i.e. stop paying your loan). While the bank takes out the policy, you pay the premium. Generally you can ‘capitalise’ the premium – meaning that instead of paying it upfront in one hit, you roll it into the total amount you owe, and it becomes part of your regular mortgage repayments.

This additional cost is typically required when you have less than 20 per cent savings, or a loan with an LVR of 80 per cent or higher, and it can run into thousands of dollars. The policy is not transferrable, so if you sell and buy a new house with less than 20 per cent equity, then you’ll be required to foot the bill again, even if you borrow with the same lender.

Some lenders, such as the Commonwealth Bank, charge customers with a small deposit a Low Deposit Premium or LDP instead of LMI. The cost of the premium is included in your loan so you pay it off over time.

How can I avoid mortgage insurance?

Lenders mortgage insurance (LMI) can be avoided by having a substantial deposit saved up before you apply for a loan, usually around 20 per cent or more (or a LVR of 80 per cent or less). This amount needs to be considered genuine savings by your lender so it has to have been in your account for three months rather than a lump sum that has just been deposited.

Some lenders may even require a six months saving history so the best way to ensure you don’t end up paying LMI is to plan ahead for your home loan and save regularly.

Tip: You can use RateCity mortgage repayment calculator to calculate your LMI based on your borrowing profile

Which mortgage is the best for me?

The best mortgage to suit your needs will vary depending on your individual circumstances. If you want to be mortgage free as soon as possible, consider taking out a mortgage with a shorter term, such as 25 years as opposed to 30 years, and make the highest possible mortgage repayments. You might also want to consider a loan with an offset facility to help reduce costs. Investors, on the other hand, might have different objectives so the choice of loan will differ.

Whether you decide on a fixed or variable interest rate will depend on your own preference for stability in repayment amounts, and flexibility when it comes to features.

If you do not have a deposit or will not be in a financial position to make large repayments right away you may wish to consider asking a parent to be a guarantor or looking at interest only loans. Again, which one of these options suits you best is reliant on many factors and you should seek professional advice if you are unsure which mortgage will suit you best.

When do mortgage payments start after settlement?

Generally speaking, your first mortgage payment falls due one month after the settlement date. However, this may vary based on your mortgage terms. You can check the exact date by contacting your lender.

Usually your settlement agent will meet the seller’s representatives to exchange documents at an agreed place and time. The balance purchase price is paid to the seller. The lender will register a mortgage against your title and give you the funds to purchase the new home.

Once the settlement process is complete, the lender allows you to draw down the loan. The loan amount is debited from your loan account. As soon as the settlement paperwork is sorted, you can collect the keys to your new home and work your way through the moving-in checklist.

What is a credit file?

A comprehensive summary of your credit history from an authorised credit reporting agency.

It includes your credit details, credit taken in the last five years, any default payments or credit infringements, arrears, repayment history, bankruptcy filings and a list of credit applications (including unapproved credit applications) in addition to your personal details.

When should I switch home loans?

The answer to this question is dependent on your personal circumstances – there is no best time for refinancing that will apply to everyone.

If you want a lower interest rate but are happy with the other aspects of your loan it may be worth calling your lender to see if you can negotiate a better deal. If you have some equity up your sleeve – at least 20 per cent – and have done your homework to see what other lenders are offering new customers, pick up the phone to your bank and negotiate. If they aren’t prepared to offer you lower rate or fees, then you’ve already done the research, so consider switching.

How can I get a home loan with no deposit?

Following the Global Financial Crisis, no-deposit loans, as they once used to be known, have largely been removed from the market. Now, if you wish to enter the market with no deposit, you will require a property of your own to secure a loan against or the assistance of a guarantor.