How Decreasing Term Life Insurance Works
Term life insurance is a type of life insurance where you pay a premium and receive a death benefit in return. There is no cash value and the policy lasts for a set number of years, which is called the "term." A particular type of term policy is a decreasing term policy.
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Function
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Decreasing term life insurance has a death benefit that decreases over time. The death benefit normally decreases according to a specific schedule. The schedule is almost always in sync with a mortgage, but may be scheduled to decrease with other types of loans.
Significance
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The decreasing term policy ensures that you have coverage only for the liability you are insuring. This means you are not buying more life insurance than whatever the liability amounts to. For example, if you purchase a $200,000 home and your mortgage is $160,000 after your down payment, and your decreasing term policy starts at $160,000, your policy will decrease every year as your mortgage balance gets paid off. The death benefit of the policy will equal, or be very close to, your mortgage balance every year.
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Benefits
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The benefit of a decreasing term policy is that you are never overpaying for life insurance. Because the policy's death benefit decreases, you will always be purchasing the correct amount of insurance. This also saves you money over the life of the liability you are insuring. The insurance company can know, in advance, what your insurance premium costs will be, and the level premium amount reflects the total cost for insurance over the entire time you hold it, while the death benefit decreases.
Drawbacks
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Decreasing death benefits compartmentalize your insurance needs. This means your life insurance policy is never able to provide insurance coverage for more than one thing at a time. For example, a level death benefit policy taken out on a mortgage could provide insurance coverage for other financial obligations you incur over time, even as the mortgage balance decreases. You won't need to buy another policy. With a decreasing term policy, you must buy a separate policy for each liability you want to insure, and the policy ends when the liability is paid off.
Considerations
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Compare a decreasing term policy with level term life insurance. Make sure you don't expect any major financial liabilities in your future when you purchase a decreasing term policy. Consider the total costs of purchasing separate policies to cover all of your financial obligations, versus buying just one policy that stays level for the entire term.
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