Term plan-backed home loan protects your family from repayment burden

The group life cover offered by banks could be your second option if you are unable to get a term plan due to health-related reasons

During the Covid pandemic, many families have lost their breadwinners. If they had taken a large home loan, and have not purchased an insurance policy to cover this liability, they stand the risk of their house being repossessed by the bank. More tragically, there have even been cases where the borrower purchased an insurance policy but his family is still being denied compensation. The reason: The borrower either bought, or was mis-sold, a policy that does not cover death. Such families, too, could lose their homes.

What to steer clear of

Many types of policies are sold under the moniker “loan protector cover”. Borrowers can not go just by the name of the cover but must understand exactly what the policy covers.

General insurance companies, for instance, sell policies that pay up in case the insured contracts one of the named critical illnesses, personal accident and disability, and job loss (different policies may cover different permutations of these risks). “The primary risk in a home loan is that of the insured losing his life and his family being unable to pay the EMIs. This risk needs to be covered by purchasing a life policy. Policies that cover these other risks like critical illnesses, personal accident, and so on can at best be an add on to the main life cover, but not a replacement for it,” says Gaurav Gupta, founder and chief executive officer, MyLoanCare.in.  

Sometimes, home (property) insurance, which covers the building and the possessions inside against risks like fire, natural calamities, etc. is also mis-sold to borrowers. Again, the homebuyer can buy this policy too but only after he has purchased adequate life cover.   
 

Key policies you may choose from

The home loan borrower can choose from one of these three types of policies when trying to cover the liability of a home loan:

Home loan cover-group: The first option is a group policy that covers the borrower’s life. Sometimes it is called group credit shield. This is primarily the policy that the bank is likely to sell to a home loan borrower (a life insurer is the manufacturer). The lender is the beneficiary in such a policy. Any payout made goes to the lender and not to the borrower’s nominee. The limited advantage of such a policy is that in case of the borrower’s demise, the loan is settled automatically and the borrower’s family does not have to do anything.

This type of policy has quite a few downsides. As money is paid directly to the lender, the family does not have any say in what to do with the money.

These are single-premium plans. Often, a borrower may have taken the loan for 20 years but repays it within seven years. Once he closes the loan, the policy lapses. The premium for the balance13 years goes waste.

These days borrowers also switch from one lender to another to save on interest cost. In this event, again, the group cover lapses.

Home loan cover-individual: This is the individual version of the policy described above. More players offer the group cover now; only a few offer the individual cover. “In this cover, the borrower is the principal, not the bank. Even if the person switches his loan from one bank to another, his cover continues,” says Gupta. These policies are likely to cost more than the group cover.

Term insurance: This is the pure life cover that one buys from a life insurance company to safeguard one’s family against the risk of the breadwinner passing away prematurely. Experts say a term plan that is bought independently (and not from the bank giving the loan) after comparing premiums and features is the best of all options.

In this case, the payout from the policy goes to the nominee. The latter can decide whether to use it to pay off the loan or for another purpose. “If the spouse earns, she/he may be in a position to continue paying the EMI. She/he then has the flexibility to invest the money from this policy for other financial goals of the family,” says Adhil Shetty, chief executive officer (CEO), Bankbazaar.

The premium is paid annually, so the burden is lower. A group cover is a single-premium policy. Borrowers often take a second loan from the lender to pay the massive single premium and end up paying an EMI on that loan too.

If the borrower pre-pays the loan, he can terminate a term policy without any loss of premium.

“Borrowers should supplement the term cover with a personal accident and disability rider,” says Shetty.     

There is one issue with a term plan. “The borrower may have to undergo medical tests. This is not required in a group cover,” says Kapil Mehta, co-founder and managing director, Secure Now Insurance Broker.    

Don’t fall prey to coercion

One unseemly aspect of taking a home loan is that the lender often coerces the borrower into buying an insurance policy. In many cases, lenders have been known to threaten that the loan will not be sanctioned unless the borrower buys an insurance policy. “The regulators frown upon such forced cross-selling,” says Mehta. If the lender insists, ask it to give you in writing that sanctioning of the policy is contingent on the purchase of a policy. Most will back off at that point.

Sometimes, lenders announce special rates, say, around festival time. Again, they insist that those rates will only be offered to customers who buy an insurance policy from them. “Pay the 10-15 basis points higher interest rate but still go with a term policy that you have bought independently because of the greater flexibility it offers,” says Gupta.

Constant or reducing cover?

The group covers sold by banks offer both these options. The positive aspect of a constant cover is that if there is any money left after paying off the loan, it goes to the family.

In reducing covers, the sum assured declines as the principal outstanding reduces. This type of policy tends to be cheaper than a constant cover.

But there is one catch in a reducing cover that the insured must be aware of. The policy sum insured decreases in line with the original loan repayment schedule. Suppose interest rates begin to rise after you have taken the loan. The lender usually increases the tenure and keeps the EMI constant. “When this happens, you will repay the principal at a slower pace than in the original amortisation. Meanwhile, your insurance cover will fall in line with the original schedule. In such a case, there is the risk that you could become under-insured,” says Deepesh Raghaw, founder, PersonalFinancePlan, a Securities and Exchange Board of India-registered investment advisor.

Most buyers do a lot of due diligence on the home they are buying. Some also pay some attention to the interest rate and other features of the home loan they take. But when the bank or non-bank finance company cross-sells an insurance cover, most sign blindly on the dotted line without checking what the policy covers. Given the high price their family could end up paying for their oversight, borrowers need to exercise more caution.

How much does it cost to cover home loan?

These are indicative rates for a 40-year-old buying a 10-year cover for every Rs 1,000 of sum assured

• A term plan will cost around Rs 9-16; most insurers offer them in the Rs 10-12 band
• The group credit shield product will cost Rs 10-13 (there are some outliers)
• Although the rates for term and group credit shield appear similar, the difference is that the term cover has a flat sum assured for 10 years whereas the group credit shield has a reducing sum assured (so the former is more cost-effective) 
• A group personal accident cover is much cheaper at one rupee

Source: Secure Now Insurance Broker