How Decreasing Term Life Insurance Works

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Decreasing term insurance is popular among homeowners who want to ensure that their mortgage will be paid off in the event of their death, easing the financial burden on loved ones. But you should also assess your specific financial needs and obligations to determine whether this insurance is the right choice for you.

A financial advisor can help you create a financial plan to pay off debt and an estate plan to protect assets for your family.

How Decreasing Term Insurance Works

Decreasing term insurance, also known as mortgage life insurance or mortgage protection insurance, is a type of life insurance policy where the death benefit gradually decreases over time. This type of insurance is often used to cover specific financial obligations that decrease over the years, such as a mortgage or other loans.

Here are seven things you should know about this life insurance:

Coverage duration: The policy is typically purchased for a specific period, such as the duration of a mortgage or loan. It is designed to align with the length of the financial obligation it’s meant to cover.
Declining death benefit: Unlike traditional life insurance policies where the death benefit remains constant, the death benefit in decreasing term insurance decreases over the policy’s term. The reduction is usually set in line with the outstanding balance of the mortgage or loan.
Purpose: Decreasing term insurance is often used to provide financial protection to beneficiaries, such as family members or dependents, in the event of the policyholder’s death during the term of the policy. The decreasing death benefit is intended to closely match the declining outstanding balance of a mortgage or loan.
Premiums: Premiums for decreasing term insurance policies are often lower than those for traditional life insurance policies because the death benefit decreases over time. However, the premiums remain consistent throughout the policy term.
Non-cash payout: If the policyholder passes away during the policy term, the beneficiaries receive a payout based on the remaining death benefit. This payout is typically paid out as a lump sum.
No cash value: Unlike some types of permanent life insurance policies, decreasing term insurance policies usually do not accumulate cash value over time. The policy’s primary purpose is to provide coverage for the specified financial obligation.
Conversion option: Some policies may include a conversion option that allows the policyholder to convert the decreasing term insurance policy into a different type of policy, such as a whole life or universal life insurance policy, without the need for a medical exam.

Decreasing Term Life vs. Level Term Life

When choosing life insurance, make sure you consider your specific financial goals, obligations, and protection needs. Here are eight key differences between decreasing term life and level term life insurance:

Death benefits: While decreasing term life death benefits decrease over time, often aligning with the outstanding balance of a specific loan, while level term life death benefits remain constant throughout the policy term.
Purpose: Decreasing term life is primarily used to cover specific financial obligations that decrease over time, like a mortgage or loan. Level term life, on the other hand, offers broader financial protection and can be used for various purposes such as income replacement, debt coverage and education funding.
Premiums: Decreasing term life premiums remain constant throughout the policy term and are generally lower than those of level term life insurance. But level term life premiums are typically higher due to the constant death benefit and broader coverage.
Cash value: Decreasing term life generally does not accumulate cash value. And most level term life policies also do not accumulate cash value, though some variations like return of premium (ROP) policies offer a refund of paid premiums if the policyholder outlives the term.
Coverage duration: Decreasing term life typically matches the term of a specific loan, such as a mortgage. However, level term life is purchased for a specific term, like 10, 20, or 30 years, based on the policyholder’s needs.
Beneficiaries: If a decreasing term life policyholder dies during the term, beneficiaries receive a payout based on the remaining death benefit. But when level term life policyholders die during the term, beneficiaries get a payout based on the level death benefit.
Conversion option: Both some decreasing term life and level term life policies can offer a conversion option to switch to a different policy type without a medical exam.
Suitability: Decreasing term life can be suitable for individuals who want to cover specific decreasing financial obligations, like a mortgage. Level term life is suitable for broader coverage needs, such as income replacement, debt coverage, education funding, etc.

Benefits of Decreasing Term Insurance

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Here are 10 common benefits of decreasing term insurance to consider:

Cost-effective: Premiums for decreasing term insurance are generally lower compared to other types of life insurance, making it an affordable option for coverage.
Tailored to specific obligations: Decreasing term insurance is designed to align with specific financial obligations that decrease over time, such as a mortgage. This ensures that the coverage matches the decreasing debt.
Mortgage protection: It provides financial protection to beneficiaries in the event of the policyholder’s death, ensuring that a mortgage or loan can be paid off, relieving loved ones of that financial burden.
Simplicity: The concept is straightforward. The decreasing death benefit corresponds to the decreasing balance of the obligation it’s intended to cover.
Focused coverage: It targets a specific financial need, which can be valuable for individuals who want to ensure that their debts are covered if they pass away prematurely.
Term flexibility: The policy can be tailored to match the term of the financial obligation, offering coverage for the duration needed.
No cash value worries: Since it’s focused on providing a death benefit to cover a specific obligation, policyholders don’t need to worry about the cash value component found in some other policies.
Conversion option: Some policies offer a conversion option, allowing policyholders to convert the decreasing term policy into a different type of policy, such as a permanent life insurance policy, without a medical exam.
Protection for loved ones: Beneficiaries are safeguarded from the potential financial strain of the outstanding debt, allowing them to maintain their living situation and financial stability.
No medical exam for conversion: If a conversion option is available, policyholders can switch to a different type of policy without the need for a medical examination, even if their health has changed.

Examples of When to Get Decreasing Term Insurance

Here are 10 common examples of situations where a decreasing term insurance policy might be beneficial:

Mortgage protection: A common use case is to cover a mortgage. As you pay down your mortgage balance over time, the coverage amount decreases in line with the remaining mortgage debt. This ensures that if you pass away before the mortgage is paid off, your loved ones can use the insurance payout to settle the mortgage.
Loan repayment: If you have other outstanding loans like personal loans or car loans, a decreasing term policy can help ensure that these debts are taken care of if you’re no longer around to pay them off.
Business loans: Business owners might consider decreasing term insurance to cover business loans. This protects the business and its co-owners in case of the policyholder’s death, preventing the loans from becoming a burden on the business.
Education funding: Parents might use a decreasing term policy to ensure that their children’s education expenses are covered, especially if they’re paying for education with a loan that they’d like to protect their family from.
Single financial obligations: Any financial obligation that has a decreasing balance over time could be covered using this type of insurance. This might include credit card debt, home equity loans, or any other form of loan.

Term life insurance alternative: If you’re looking for term life insurance but have specific obligations you want to cover, a decreasing term policy can be a targeted alternative.
Matching coverage to debts: As you age and your financial obligations change, decreasing term insurance can help you match your coverage to those obligations.
Temporary needs: If you anticipate that your financial obligations will reduce significantly over time, a decreasing term policy might provide cost-effective coverage for the specific period of need.
Estate planning: Incorporating decreasing term insurance can be part of your estate planning strategy to ensure that specific debts are taken care of without burdening your beneficiaries.
Supplementing other policies: If you already have other forms of life insurance but want to ensure that specific obligations are covered, a decreasing term policy can provide targeted coverage.

Bottom Line

Couple completes an insurance policy application

Decreasing term insurance can be particularly advantageous for individuals who want to provide coverage for specific loans or financial obligations and want a cost-effective solution that aligns with the decreasing balance of those obligations. It’s important to carefully evaluate your needs and compare policies to ensure you’re getting the right coverage for your situation.

Life Insurance Tips

A financial advisor can help you pick the best life insurance options for your finances. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
If you want to know how much life insurance you need, SmartAsset can help you find a personalized policy for your financial circumstances.