Q: I just read that mortgage insurance basically protects the lender in case of default, but what if you have mortgage insurance and the borrower dies; what happens to the family members that are still living in the residence in reference to the outstanding mortgage?
What is mortgage insurance?
A: Mortgage insurance (also called Private Mortgage Insurance) is required for all mortgages sold to Fannie Mae or Freddie Mac that start with less than a 20 percent down payment. This is a policy paid for by the borrower but protects the lender in the case of default, covering at least a portion of the potential loss. There is no benefit paid to the borrower.
When the mortgage holder dies…
This is the case even if the borrower on the mortgage should die; usually, the property passes to his or her estate, the monthly payments are made, and the policy to protect the lender remains in force. If there is a will, the executor becomes responsible for making payments on behalf of the estate, and this continues until the estate is settled, and the property transferred to a new owner or sold.
Regardless, provided the payments are made by someone the mortgage and policy remains in place.
If payments are not made (the loan goes into default), foreclosure proceedings begin and the lender will eventually be paid from this mortgage insurance policy for his costs of foreclosure (legally reacquiring the property and preparing it to be sold).
Credit life insurance
There is a kind of "credit life" insurance, often marketed as "mortgage insurance," which is an actual life insurance policy, usually for the face amount of the mortgage. If the borrower has such a policy and passes on, the policy pays out.
However, these policies may directly pay the lender; that is, the survivor(s) gets nothing but a paid-off mortgage. Because of this, it's usually a better idea to simply take a low-cost term life policy payable to the survivor(s), who can then pay off the mortgage or not as needs dictate.