When taking out a mortgage, you’ll go through affordability checks, and you may have reviewed your own budget. These will consider how affordable a mortgage is while earning your current income, but how would you cope financially if your income stopped?
There are a variety of reasons your income may stop, and some of them are out of your control. When you’re taking out a new mortgage, it’s a good time to review how you’d cope financially if this happened. It’s not easy to think about, but it can improve your financial security if the unexpected occurs.
A late mortgage repayment will show up on your credit report and could affect future applications for credit, such as personal loans or a credit card. If you’re struggling, lenders will work with you to find a solution. However, there are cases where homes are repossessed, so it’s important to think about what you’d do if your income unexpectedly stopped.
When assessing how long you would cope financially, there are three areas to consider.
1. Your emergency fund
Ideally, you should have an emergency fund that you can draw on if your income stops. This can provide you with a safety net until you’re well enough to go back to work or find another source of income.
Calculating your regular expenses can help you understand how much you should have saved in a rainy day fund. It’s often suggested that it should hold three to six months of expenses. This money should be easily accessible in case you need it. An emergency fund can provide some immediate relief if you find your income stops and means that you can keep up with mortgage repayments and other bills.
2. Your employer’s sick pay policy
Statutory Sick Pay provides just £96.35 each week if you’re too ill to work for a maximum of 28 weeks. For most families, this amount will not be enough to cover their mortgage or other essentials. The time limit also means those with a serious illness or who need longer to recover could face financial difficulties.
However, your employer may offer more comprehensive cover that could provide you with security. For instance, some will pay your salary or a portion of it for a defined period. This can give you peace of mind if you’re ill or injured for the short and medium term.
You should check your contract or speak to your employer if you have any questions about their sick pay policy.
3. Income protection policies you can take out
An income protection policy can provide you with an income when you need it most. If you’re too ill or injured to work, an income protection policy will pay out a regular income, usually a percentage of your regular salary, until you return to work, retire, or the policy term ends.
This can provide you with financial certainty and allow you to focus on what’s most important. You can choose the level of cover an income protection policy provides. You can also choose a longer deferment period to complement your employer's sick pay policy or other steps you may have taken.
Another option to consider is critical illness cover. This would pay out a lump sum if you’re diagnosed with a critical illness that’s named within the policy. This could help you pay off your mortgage and keep up with other financial commitments.
Yet, many mortgage holders are choosing not to take out financial protection.
According to a report from the Association of Mortgage Intermediaries, while 60% of people insure their contents, just 7% take out income protection and 9% take out critical illness cover. Almost 4 in 10 people feel like they don’t need any protection. While some may be secure without an income, many will struggle. Taking a look at your finances can help you assess if financial protection can add value to your financial plan.
Among the other reasons people choose not to take out financial protection are associated costs. The premiums you will need to pay will vary depending on the level of cover you want, your health, and lifestyle. It may be lower than you expect, so it’s worth shopping around for a deal that suits you.
Some people may also have concerns that policies won’t pay out when they need it. Figures from the Association of British Insurers show that £6.2 billion was paid out in 2020 through various financial protection policies. In 2020, 86.5% of claims in income protection policies were paid out, with an average claim of £22,170.
If you’d like to talk about the steps you can take to provide financial security when you’re paying off a mortgage, please contact us.
Please note: This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.
Life Assurance plans typically have no cash in value at any time and cover will cease at the end of term. If premiums stop, then cover will lapse. Plans may not cover all the definitions of an illness. The definitions vary between product providers.