Believe it or not, there was a time (the good ole days) when decreasing term insurance was popular. Consumers primarily used it to cover a debt so it would be paid off if you died during the repay period of the debt.
If a consumer elects to cover debt with life insurance on their own, they would use decreasing term insurance. If they elected to cover the debt and purchased the life insurance through the lender, it’s known as credit life insurance.
Decreasing term and credit life insurance serve the same purpose and they are basically the same thing except the credit life insurance policy would list the lender as the beneficiary but the decreasing term insurance policy typically did not.
In this article, we’ll discuss decreasing term insurance and find out if it’s dead or alive.
What is Decreasing Term and how does it Work?
A decreasing term life insurance policy is generally purchased (or used to be purchased) to cover a financial obligation such as a mortgage in the event the borrower dies before the loan is paid in full. The policy was designed for consumers who took on debt and didn’t want to go through the hassle of changing an existing policy they had previously purchased.
Most companies will not allow for the death benefit to be changed in an in-force policy anyway so being able to purchase a policy specifically to cover a debt made sense.
For example, if you were to purchase an expensive car or boat and wanted to make sure the loan would be paid off if you died unexpectedly, you would purchase a decreasing term policy with the death benefit matching the outstanding loan amount. As you paid the loan down each year your insurance coverage would go down proportionately until the loan and the death benefit had a zero balance.
The issue most consumers had with the product is that the premium for the cost of insurance did not go down as the death benefit decreased so they expected the policy to be substantially lower than a level term policy. At first, it was but then it wasn’t.
Ideas are great until they’re not. Marketing works until it doesn’t. Decreasing term life insurance makes financial sense until it doesn’t.
As the term insurance market became more and more competitive, purchasing a decreasing policy just didn’t make sense when you could buy a level term policy for just a little more and know that a level death benefit would be available for the life of the policy.
Why would someone even purchase Decreasing Term Insurance?
The theory behind decreasing term made sense. If you took out a mortgage for $300,000 for 30 years, you purchase a 30-year decreasing term policy so that the death benefit would be reduced each year to cover the lower balance of the mortgage.
Having life insurance to cover your mortgage balance provided peace of mind knowing that you would leave a paid-for home for your surviving loved ones.
What went Wrong?
Although the marketing theory behind decreasing term insurance was solid, the real-life consequences caused the marketing theory to fail.
- The monthly premium didn’t go down as the benefit went down.
- There was virtually no savings versus traditional term life insurance.
- Lenders did not require all borrowers to purchase life insurance and when they did, they wanted to be the point-of-purchase and earn a commission.
- Few companies were competing for this market and even less are today
- There was no return of premium option
What is the Alternative to Decreasing Term Insurance?
Although the theory behind decreasing term insurance is valid, unless life insurance companies got behind the concept is would end up dead in the water. They didn’t and it died.
There is an alternative, however, and it’s called “Laddering.” By laddering (or layering) multiple term insurance policies that would expire as your debts are paid, you could accomplish the goal only paying for the amount of insurance you actually need. Here’s an example:
Richard is a 35-year old married dad with two kids who wants to purchase enough term insurance to replace his income and make certain his wife has a paid-for home in the event of his death.
Richard got a super deal on a 3 bedroom fixer-upper and the mortgage is only $200,000 with a 15-year term. Finally, Richard wants to make sure that his family will have $500,000 if he should die within the next 30-years. Here’s how he can do this using Laddering:
Mortgage Needs: Purchase a $200,000 15-year level term policy with his wife as the primary beneficiary. If he dies while the mortgage has a balance, his wife can pay it off and keep anything left over.
Replacement Income: Purchase a $500,000 30-year term policy with his wife as the primary beneficiary. Richard believes that this will be enough money to pay his family’s living expenses for at least 10 years and not be stressed with losing his income.
Here’s what Richard’s life insurance would like for the next 30 years:
$200,000 15-year term: $158.00 per year
$500,000 30-year term:$497 per year
As you can see with Richard’s example, by laddering his term life insurance policies to accommodate his needs, Richard’s cost of life insurance would be $655 for 15 years but would go down to $497 when the 15-year term policy expires along with his mortgage.
How Laddering Term Insurance Saves Money
During the first 15 years of coverage, Richard’s wife would receive a $700,000 death benefit and then a $500,000 death benefit for the remaining 15 years of coverage.
When the $500k policy is about to expire, Richard can elect to renew the policy and pay a premium based on his attained age or he could convert all or some of that term life coverage to permanent life insurance without having to worry about his health at age 65.
When Decreasing Term isn’t a good option – call an Independent Agent for Answers
If you are considering using decreasing term insurance to cover personal debt and find it’s not a viable solution (and you will), call us at (800) 712-8519 or contact us through our website for an alternative solution like laddering multiple term life insurance policies.
We’re confident that we can save you money on your life insurance and provide advice that will bring you peace of mind regarding your outstanding debts and what would happen if you’re no longer here to pay them.
You can start by using our instant quote form on the right or contact us through our website today!
Frequently asked Questions
Is decreasing term the same as credit life?
Decreasing term life is basically the same except that credit life insurance typically has the lender listed as the beneficiary.
Is decreasing term cheaper than level term?
If you can even find decreasing term insurance it will generally not be cheaper than traditional level term because the competition in term insurance has substantially lowered rates.
What’s the alternative to decreasing term?
A great alternative to decreasing term insurance that can save you considerable premium dollars would be to ladder multiple term policies. Check with an insurance professional to get information on you can easily ladder (layer) your insurance coverage.
How does decreasing term compare to level term?
In simple terms, the death benefit in a level term or traditional term policy remains the same while the death benefit in a decreasing term policy goes down each year to only the cover the amount of the outstanding loan it’s supposed to cover.