What’s Decreasing Term Life Insurance? Cost, Pros + Cons

Updated

Life insurance isn’t really for you but for the people you leave behind. Most people don’t enjoy thinking about end-of-life planning or life insurance because it can feel scary or sad. Yet it’s a fact of life that we have to prepare for our death if we want our spouse and kids to remain financially secure. After all, you wouldn’t want your family to lose their home, car, education, or overall lifestyle. 

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If you’re looking for a life policy that can secure your family’s most prized possessions, then you may want to think about decreasing term life insurance. It’s a very specific type of coverage that some people find beneficial. 

Decreasing Term Life Insurance Defined 

Decreasing term policies have a death benefit that’s equal to a large loan. Most people take out a decreasing term plan that covers the balance on a mortgage, car, personal or business loan. 

The “term” is the same length of time as the timeframe for the debt repayment. As you pay down the loan, the death benefit amount also decreases. This type of life insurance product is also known as a Mortgage Protection Insurance (MPI) policy. 

Here's an example. You take out a $100,000 mortgage that must be paid off within 30 years. You sign up for a decreasing term insurance policy that also has a 30-year term. You can make the home lender your life insurance beneficiary so that upon your passing, the home loan is paid in full. 

This end-of-life planning method can leave your spouse and children free of a future mortgage payment, rather than giving them a monetary payout. 

What’s the difference between decreasing term life insurance and level term insurance? 

There are lots of life insurance products available these days. Don’t feel bad if you were unaware of all the different options available. Let’s break down the difference between decreasing term and level term life insurance.  

Level term life insurance: You can probably figure out from the title that this coverage guarantees the same premium and death benefit for the entire length of the contract. Level term coverage lasts for a set period (usually between 10 years and 30 years). You can also cancel a level term life whenever you want.  

Decreasing term life insurance: This life insurance can also be set for a predetermined period, generally anywhere from 1 year to 30 years. The premiums stay the same for the entire contract, but the death benefit gradually shrinks over the length of the term. Overall, premiums for this type of plan are lower than a level term policy.  

The death benefit on a decreasing term life policy decreases because it’s linked to a debt (often, a mortgage). The death benefit is the remainder of that debt. So as you pay down the debt, less is needed to pay off the remainder. 

How Does Decreasing Term Life Insurance Work?

You may not know much about how this type of insurance works. This is probably because it’s not nearly as common these days. 

Who pays the premium? 

You pay the premiums either monthly or annually, based on your policy terms. The premium for most decreasing term life insurance policy is fixed, but the death benefit decreases. 

How do payouts work?

All life insurance proceeds are paid after the insured individual has passed away. To claim the death benefits, the named beneficiary of the policy will have to request the funds from the insurer. Many decreasing term life insurance payouts are paid out to the insured’s bank, mortgage company, or another lender, making this lender the beneficiary.

For any beneficiary to file a death claim, they must complete the insurer’s claim form and submit it along with an original, certified death certificate. Normally, death claims are completed within 30 to 60 days. Of course, this is true if there aren’t any complications like a homicide or suicide. 

Who typically sells this type of insurance?

Lenders, such as mortgage companies, often sell decreasing term life insurance. As we mentioned earlier, the lender might refer to this type of policy as Mortgage Protection Insurance (MPI). You can also talk with your insurance agent or financial planner about buying a life insurance plan. There are lots of online resources that can be used for finding the best life insurance possible, as well. 

Who Is Decreasing Term Life Insurance Typically For?

Decreasing term life insurance is a unique life insurance product and may not be for everyone. Below are a few situations that could call for this type of live coverage. 

Personal debt: You have a large personal debt that you want paid off upon your passing. Keep in mind, as you pay down the loan balance, the insurance benefits also decrease. 

Lessening debt in the future: Your need for life insurance will diminish during your golden years. For example, in the future your children will be independent and will not rely on your income to survive. Therefore, you really don’t need the heavy burden of a traditional life insurance policy. 

Small business owner: If you’re a small business owner, buying this type of insurance coverage can be extremely helpful. This type of term life coverage reassures commercial lenders that your business will be able to cover any operational expenses, as well as pay back your portion of the small business loan or credit line. 

The bottom line is that a decreasing term policy can offset the financial strain of your passing for your company and business partners. 

What Are the Pros and Cons of Decreasing Term Life Insurance?

We put together a convenient list of pros and cons regarding this life insurance product. Hopefully, this information will help you decide if this type of life coverage is best for you and your loved ones. 

Pros

  • Premiums that are usually lower than other coverage
  • Less intense application process in comparison to a traditional plan
  • If your greatest concern is covering your mortgage and leaving your family home paid in full, this type of policy may be just right
  • Many parents with small children like the idea of having a larger death benefit now (while the kids are young) and a lower death benefit after the kids are independent adults 

Cons

  • The beneficiary of these plans is normally a creditor rather than a loved one. The bulk of the insurance benefit will usually go towards a debt instead of your family (who’s responsible for funeral expenses, medical bills, and other needs)
  • There’s no cash surrender value which means you won’t receive a return of premiums if you cancel the policy before term ends 
  • Far fewer carriers to pick from when it comes to buying decreasing term life coverage 
  • Living beyond the plan’s term will result in no payout in the end 
  • You’ll continually pay premiums even as the policy’s value shrinks 

Are There Any Other Alternatives to Decreasing Term Life Insurance?

Life insurance is all about finding the most affordable premium with the best coverage for you. Many people worry about making the wrong choice, but there’s no need to fret. It’s best to simply explore all your options, including these alternatives to decreasing term life insurance. 

Level term life insurance

Level term life insurance promises the same premium and death benefit for the entire length of the policy term, anywhere from 1 year to 30 years typically. Most term life coverage can be flipped to a permanent policy at the end of the term or can be canceled any time. 

Increasing term life insurance

Increasing term life insurance has a death benefit that increases over the policy term. The increase in benefits is based on inflation, as well as other factors. Premiums may or may not stay the same. The benefit will increase at a predetermined date or under certain circumstances like the policy’s anniversary date, marriage, birth, etc. 

Re-entry term life insurance 

Re-entry term life insurance is not nearly as common as other term products. This type of protection provides low premiums over a set period. If the insured can pass periodic medical exams, the premiums will remain low. You might be asked to complete a physical every three years. Obviously, this can be a risky option because once an insured has failing health, they will be expected to pay higher premiums. 

Term layering

Term layering (also called term laddering) enables you to piggyback two or more term life insurance policies to get the same effect as decreasing term policies. Parents of small children sometimes go with this option because it ensures debts are covered, at least until the kids become adults.  

Decrease Your Worries, Increase Your Peace of Mind

Purchasing life insurance is a very personal decision but so important to establishing your family’s future security. The key is to envision your family’s financial future over the next 10, 20, or 30 years.

Think about what types of resources your spouse and children will need. You’ll want to consider how much life insurance you may need and how much life coverage you can afford. It’s always worth reaching out to an insurance agent or financial planner for guidance and support during this process.


Sources:
  1. Kagan, Julia. “Term Life Insurance,” Investopedia. 31 July 2021, investopedia.com.
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