Using Life Insurance To Pay off Mortgage Debt: A Guide for Canadians

The average loan amount for new mortgages in Canada in mid-2022 was a whopping $367,500, according to Equifax

Plus, high interest rates and rising inflation are making it tougher than ever for Canadians to make their monthly mortgage payments.

That’s why it’s essential to get a term life insurance policy to make sure your mortgage can be paid off if you pass away prematurely, especially if you have dependents such as a spouse, elderly parents or minor children.

Can you use term life insurance to pay off your mortgage?

Yes. Term life insurance can be used to pay off your mortgage.

No one should have to deal with the stress of mortgage payments while grieving the loss of a loved one.

And term life insurance is better equipped to help with this than mortgage insurance, which we’ll get into below.

It’s important not to confuse term life insurance with mortgage default insurance, which protects the lender in the event that the mortgage holder is unable to make payments on their mortgage.

What about mortgage life insurance?

Term life insurance is also different than mortgage life insurance. Typically, when you get a mortgage, lenders will offer you mortgage life insurance. 

If the mortgage holder passes away, mortgage life insurance is supposed to pay off the remaining mortgage balance and ensure that dependents can continue to live in the house without having to worry about future mortgage payments. 

However, mortgage life insurance has garnered a lot of criticism, namely because it offers limited flexibility (i.e., you can only use it to pay off the mortgage), and you continue to pay the same premium even as your mortgage balance decreases over time.

Alternatively, term life insurance offers the same benefit: the beneficiary can use the payout to pay off the mortgage in the event the policyholder passes away. 

But they can also use the funds to cover many other expenses, since coverage can span from below $100,000 to over $5 million.

How does term life insurance work to pay off a mortgage?

Term life insurance covers the policyholder for a specified period of time, usually ranging from 10 to 30 years, which works well to cover the period when you still owe money on your mortgage. 

You can get a shorter coverage period if you expect to pay down your mortgage faster, which is also more affordable, though the price also depends on other factors, such as the coverage amount, your age, and your sex. Use an online term life insurance calculator to figure out exactly how much life insurance you need.

Term life insurance generates a tax-free death benefit if the insured person passes away during their coverage period. This helps the beneficiaries (the person listed in the policy who will receive the payout) deal with the financial impact of the policyholder’s death. 

The death benefit payout can be used to pay off mortgage debt and for whatever else the beneficiary wants.

What a term life insurance payout can be used for

  1. Paying off mortgage debt
  2. Paying for funeral expenses or medical bills
  3. Replacing lost income
  4. Taking time off work
  5. Paying for the dependents’ education or other needs
  6. And anything else the beneficiary wants to spend it on.

How beneficiaries can claim term life insurance to pay off a mortgage

If you’re considering getting a term life insurance policy, make sure you talk to your beneficiaries about how to claim the death benefit payout just in case. 

Here’s how beneficiaries can claim the death benefit: 

  1. Find the term life insurance policy documents, which will include details like the policy number, the claim amount, and details of other beneficiaries (if applicable). 
  2. If you cannot find the policy document, contact the insurance company to obtain a copy. 
  3. Get a copy of the death certificate of the deceased policyholder from the funeral home or hospital, confirming the time, place, and cause of death. 
  4. Submit a completed claim form that specifies your relationship with the deceased policyholder, establishes your proof of identity, and how you would like to be paid once the insurance company processes your claim. 
  5. Contact the mortgage lender to let them know you plan to pay off the loan, and inquire about any fees you might incur for paying it off before the term is up.

Be aware of mortgage prepayment penalties

While you can put the entire death benefit payout toward the mortgage loan, you’ll want to first make sure the mortgage lender doesn’t charge you a prepayment penalty.

A prepayment penalty is a fee that you may be charged when you pay more than the amount allowed or pay back your entire mortgage before the end of your term. 

Lenders make money by charging interest on your mortgage, and the longer you take to pay back the principle, the more interest they can collect. 

If you pay back your entire mortgage before your term is up, lenders lose interest and as a result, charge a prepayment penalty to recoup that loss. 

Prepayment penalties can cost thousands of dollars, so it’s important to understand the type of mortgage you have and whether a prepayment penalty would apply. 

  • If, for instance, the deceased policyholder has a closed mortgage (or you have a joint mortgage), lenders will charge a penalty if the lump sum payment exceeds your allowable prepayment privilege or if you prepay your mortgage balance before the end of your term. 
  • On the other hand, an open mortgage will allow you to make partial or full prepayments. But these mortgages come with higher interest rates.

In either case, it is worthwhile to have a conversation with your loved ones about the financial health of your family and how to prepare for the unthinkable.

Shaistha Khan

About the Author

What to read next