Three vital steps every mortgage borrower needs to take

If you're about to take out a new mortgage, you also need to take these three essential steps, says mortgage broker Tim Wilson.

I'm Tim Wilson, a mortgage broker here at lovemoney.com.

After writing my first article for lovemoney.com last month, and speaking to a lot of first time buyers, I thought I would put my fingers to keyboard again to discuss a topic that was a common theme amongst you.

Namely: mortgage insurance.

Two words that probably strike deep, deep boredom into your heart at most times in your life.... except, of course, when you're about to buy a home, and need insurance.

So I thought it might be helpful to draw on my experience as a broker over the years by writing a short guide to insurance for mortgage borrowers.

Step one: Assess your budget

As always, it is best to start by looking at your budget and identifying how much you can afford to spend to protect yourself, your family and your new home.

Step two: Assess your needs

Next step is to look at your own scenario and try to identify whether you need insurance and what you need it for.

Life insurance

For example, if you are buying a property with a partner, you are likely to need life insurance to cover the cost of paying off your mortgage. Otherwise, if you die and your partner can't keep up the mortgage payments, he or she could be thrown out of the home by the mortgage lender.

However, if you are single homeowner and no one depends on you financially, then you are far less likely to need to life insurance. So don't assume you need it.

If you do decide it's worth getting, be aware that, since there are different ways of paying off your mortgage, namely repayment and interest-only, there are different types of insurance to match them - namely, a decreasing or a level amount of cover.

What does this mean? If, for example, you have a repayment mortgage, that means the size of your debt is decreasing on a monthly basis. So you can match it with a decreasing amount of cover on your life insurance policy.

The opposite is true of an interest-only mortgage, where the debt remains level through the term - so a level insurance policy, offering a set amount of cover, would be more suitable.

Critical illness

Even if you don't have any financial dependents, there are lots of insurance policies it pays to consider buying when you take out a mortgage.

For example, if you were diagnosed with a critical illness or were ill and not able to work, how would you cope financially? Could you afford to still pay the mortgage payments? Do you get some form of sick pay through your employer?

Similarly, if you were to lose your job how long could you afford to pay the mortgage payments? I tend to find that most people have very little provision in place for such eventualities.

You can also protect your income for circumstances such as illness and injury. Income protection insurance aims to put you back in the position you were before you were unable to work. You can usually claim up to 50-65% of your income before tax.

This policy can be used for a long term and will pay out until you either return to work or retire. Again it is important to check what sick pay you get from your employer.

If you're given the option, always get insured for an inability to work at your own occupation, rather than any occupation. And check the small print.

Accident, sickness and redundancy (ASU)

This product, which is also known as Mortgage Payment Protection Insurance (MPPI), is designed to help you with your mortgage payments if you have an accident, sickness or you are made redundant. But it will only pay your mortgage up to a maximum of either 12 or 24 months. So this policy is mainly used for short term, and the premiums can be relatively high.

What's worse, often these policies are sold to people who are ineligible for them in the first place - for example, self-employed workers.

Before you take out one of these policies, read the small print very carefully and consider how much you will pay out in yearly premiums. Would you be better off saving the money for an emergency yourself?

Buildings insurance

If you are borrowing from a mortgage lender, you will need to take out buildings insurance, or you won't be able to secure the funding when you try to complete the property transaction. This is because lenders want to protect their investment, should your property be destroyed.

However, most borrowers assume that they have to take out expensive buildings insurance from their lender. In fact, this is not the case and you are free to shop around for the best policy to suit your needs.

Just to emphasise, buildings insurance is the only mandatory insurance you need to take out when you get a mortgage - the others are entirely optional and should depend on your assessment of your individual needs and circumstances.

Contents insurance

Contents insurance covers everything else that the buildings insurance doesn't. Things like your furniture, computer, entertainment equipment, CDs, DVDs, videos, valuables, clothing, personal belongings - even the food in your freezer!

Before you buy, always check to find out exactly what your policy covers. The cheaper the policy, the less cover you will get. Then again, the really expensive policies might cover things that are not essential to your needs.

Step three: Choose the right type of life insurance

Here is a small guide to show you what products are available and how they work to protect your mortgage/home:

So now you have identified whether there is a need for you to protect yourself, someone else or your home.

You should have a budget figure in mind of how much you want to spend per month.

The best thing to do now is have a play around with some quotes and scenarios and find out if the things that are important to you are affordable. You can use our life insurance service and have a go yourself to get some ideas of prices, and as always you can also drop me an email (tim.wilson@lovemoney.com) with any question or queries.

I hope this helps and as always anybody else that has some good ideas or scenarios that can help other decide please leave some comments below.

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