No one takes out a mortgage expecting that one day he or she will not be able to make the monthly payments. But things can, and do, go wrong.
And anticipating those things - unemployment, a catastrophic loss, even death - some people buy protection. That can range from mortgages that allow a few missed payments to programs that provide coverage for personal catastrophes to insurance policies that pay off the mortgage.
Deciding which form of protection is best, however, typically involves crunching some numbers.
"Our plan is geared towards the financially savvy person," said Paul Pavlishin, manager of the single-family mortgage business for Fannie Mae, which buys home loans and packages them as securities. It is the largest source of residential mortgage funds. The plan Pavlishin was referring to is Fannie Mae's new Payment Power mortgage, which lets a borrower skip up to 10 mortgage payments over the life of a 30-year mortgage.
"What makes our plan unique is that when you skip a payment, you're not just skipping payment of your principal and interest, but you're skipping taxes and insurance as well," Pavlishin said, adding that the amount skipped is then added to the outstanding balance of the mortgage.
Those who participate in the program, he said, can skip two payments, consecutive or otherwise, in any 12-month period, with a maximum of 10 skipped payments over the life of the loan.
"This program is geared towards providing flexibility and convenience for the borrower," Pavlishin said. He added that the plan is ideal for those whose income stream might not be regular - commissioned sales representatives, for example - as well as those who want the ability to direct money into other investments when the right opportunity presents itself.
"It is also ideal for first-time homebuyers who do not have a 100 percent comfort level with being in debt," he said.
There is, of course, no such thing as a free lunch.
"There are two ways the borrower can pay for this," Pavlishin said. One way is by agreeing to pay a slightly higher interest rate - generally from an eighth to a quarter of a percentage point more - at the inception of the loan. The other way is to pay a "transaction fee" whenever a payment is skipped.
"The fee is based on the original amount of the loan," Pavlishin said. For loans up to $120,000, he said, the transaction fee is $100; for loans from $120,000 to $215,000, the fee is $170; and for loans from $215,000 to $322,700, Fannie Mae's maximum loan, the fee is $230.
"The fee is paid at the time of the skipped payment," Pavlishin said. Since the amount skipped is added to the outstanding loan balance, the monthly payment is reamortized, resulting in a slightly higher monthly payment for the rest of the loan period. The amount of the monthly increase will depend on such factors as the point in the life of the loan at which the payment was skipped and the taxes and insurance on the residence.
Being able to skip two payments every 12 months, of course, would be of little help to someone unemployed for longer than that. For such people, other payment protection products are available.
The Chase Insurance Group, a subsidiary of J.P. Morgan Chase, for example, has an "involuntary unemployment" program that pays the participant's principal, interest, taxes and insurance for six to nine months in the event the borrower loses his or her job.
Paul Petrylak, president of the company, said that the product, available only to those who have J.P. Morgan Chase mortgages, costs $25 to $50 a month for a $1,000 monthly mortgage payment, depending on the duration of the coverage.
Petrylak said the coverage is intended for customers who want to be "fully protected."
To benefit from the program, he said, a customer must have coverage for at least six months before becoming unemployed and must be able to qualify for state unemployment benefits.
Another program provided by Chase Insurance Group is called disaster mortgage protection. That plan pays the borrower's monthly mortgage payments if damage to the home requires the customer to move out while repairs are being made.
"It will also pay up to $100,000 on the mortgage balance in the event of a total loss," Petrylak said, adding that the cost of such coverage is about $12.50 a month.
Another form of protection available to borrowers is known as mortgage accidental death coverage. "This pays off the loan balance in the event of an accidental death," Petrylak said, adding that the insurance also pays the policyholder's beneficiary up to 10 percent of the original mortgage amount. The cost of coverage for a $100,000 mortgage ranges from $20 to $35 a month.
Chris Pearson, owner of an Internet-based insurance referral service, said that for those who are concerned that a serious injury or disability will make it impossible to earn the money needed to pay a mortgage, disability insurance may fit the bill.
Such insurance typically pays 60 percent of the insured person's salary up to age 65 or 67. For a 40-year-old male nonsmoker in good health earning $100,000 a year, for example, a policy that would pay $60,000 a year in benefits would cost about $2,360 a year. (Rate quotes from various insurance providers are on Pearson's Web site at disability-insurance-center.com).
Perhaps the most familiar form of insurance for borrowers is the type that will pay off the entire outstanding balance of the mortgage if the insured person dies. Such coverage is known by various names, including mortgage insurance, mortgage assurance and decreasing term life insurance.
Peter Tedone, president of the Savings Bank Life Insurance Co. in East Hartford, Conn., said that his company offers a product called mortgage life insurance through a number of lenders.
"Simply stated, it is group term life insurance you buy through the lending institution," Tedone said. "The lender collects the monthly premium along with the monthly mortgage payment, and in the event of death of the borrower, the balance of the mortgage is extinguished."
While many borrowers are offered this form of insurance, Tedone said, there are pros and cons to buying it. One benefit, he said, is that there typically is no medical examination required to buy the coverage. Another is that paying for and ultimately applying the coverage is automatic: Premiums are included in the monthly mortgage payment and, in the event of the death of the insured, the mortgage is automatically paid off.
That latter point, however, could also be viewed as a disadvantage.
"Mortgage life insurance doesn't give you much flexibility," Tedone said, explaining that since the mortgage is automatically paid off upon the death of the insured, the survivor does not have the option of using the insurance for other purposes. Even more significantly, he said, the amount of coverage a person with mortgage life insurance has decreases as the outstanding balance is amortized through monthly payments.
"If you're looking for an easy way to cover your mortgage, mortgage life insurance can be a simple way to do that," he said. He added that for those who want more control over their coverage, it typically makes more sense to buy "level term life insurance" for at least the amount of the mortgage.
Suze Orman, author and host of the personal finance program on CNBC, expressed strong feelings on the subject.
"In my opinion, mortgage life insurance makes absolutely no sense whatsoever," Orman said, noting that in addition to the fact that the amount of coverage decreases with the balance of the mortgage, such coverage typically has to be bought all over again - and at rates at least partially dependent upon the borrower's age - when a new mortgage is taken out.
"You're far better off getting a term life insurance policy," which is cheaper, she said, pointing out that at present, it is possible for a healthy 52-year- old man to buy $500,000 worth of insurance for 20 years for as little as $115 a month.
Annually renewable term insurance - which is bought for one-year terms with coverage for subsequent years being guaranteed and with premium increases that take into consideration only the age of the insured - also is available.
"And with life insurance," Orman said, "if your beneficiaries don't want to use the money to pay off the mortgage, they don't have to."