Term plan works better for covering home loan liability, say experts

Home loan protection plan may only cover accidental death, which could leave the borrower's nominees exposed

With home purchases bouncing back, home loan volumes are also set to rise. A home loan is usually the largest financial liability a person takes. Failure to repay the home loan means the lender could take over the house, which has been mortgaged to it.

To avoid such a situation, it makes sense for borrowers to purchase a life insurance cover that will protect them against the risk of their family losing the home.

Two options

Two types of life insurance covers can be purchased to safeguard against risk of the borrower’s untimely death.

The first option is a traditional term plan. In case of death, the life insurer pays the sum assured to the family, and the latter can use this money to pay off the home loan.

Two, the borrower can buy a home loan protection plan (HLPP) or mortgage reducing term insurance through the lender. In this case, the lender buys a group policy to cover all its home loan customers. This plan’s sum assured reduces as the principal outstanding reduces (as the loan is repaid).  

“HLPP covers one’s outstanding home loan amount in case of accidental death, disability or critical illness. The lender will not seize the house or the collateral from the family to recover the loan amount. Instead, it is the onus of the mortgage insurance provider to pay the outstanding loan amount to the lender,” says Indraneel Chatterjee, co-founder, RenewBuy.

Easy to purchase

HLPP, which is purchased through the lender, is easy to buy. Usually, there is no mandatory medical test. The borrower just has to sign a declaration of good health.

“The tie-ups between lenders and insurers ensure a smooth experience for customers. They don’t have to worry much about documentation. Even in case of the borrower’s demise, the beneficiary doesn’t have to get involved in settling the loan amount,” says Rakesh Goyal, director, Probus Insurance Broker.

Borrowers can pay the premium either as a single premium or as a regular payment that is bundled with the home loan EMI.

When a home loan is taken in joint name and two or more borrowers are going to contribute to the loan repayment, all of them should be insured. If only one borrower is insured and the other dies, the burden to repay falls on the survivor.

“HLPP can be taken jointly and cover all co-applicants,” says Chatterjee.

Term cover option

With a pure term plan, there is no connection between the lender and the insurer.

The borrower has to procure the term policy on his own. He may have to undergo medical tests and other underwriting requirements.

Some term policies allow the buyer to choose from a couple of claim settlement options – lump sum or monthly pay-outs to the beneficiary.

If the term cover is being purchased to cover a home loan, the lump-sum option should be chosen.

Opt for a term cover

In most cases, a separate term-life policy works better. It is easier to do cost comparison of term insurance premiums from different insurers and buy what suits your pocket. “Unlike term insurance plans or general insurance policies, the premium cost per lakh of HLPP is not easily available. It depends on the tie-up between the lender and the insurer,” says Pankaj Bansal, chief business officer, BankBazaar.com.

Deepesh Raghaw, founder, PersonalFinancePlan and a Securities and Exchange Board of India (Sebi)-registered investment advisor, said, “HLPP is quite an expensive cover. Banks sell this product because they get a hefty commission on it.”

Even if you prepay your home loan, your term cover remains active. “A term plan is a comprehensive form of coverage that offers a death benefit, which can be utilised for any need. HLPP only covers the amount of the outstanding loan,” says Sajja Praveen Chowdary, head-term life insurance, Policybazaar.com.

If you opt for a term-life cover, buy separate policies to cover the loan for all the co-borrowers in a home loan for a sum assured equal to the home loan amount.

Points to watch out for in HLPP

• Check what the policy covers: Does it cover the borrower’s life, or does it cover accidental death, critical illness, or job loss?
• Death can happen due to a variety of reasons, not just due to an accident; so the policy must cover the borrower’s life
• Is the HLPP a reducing cover or a level cover?
• In a reducing cover, the sum insured will reduce in line with the loan’s original amortisation schedule
• In a rising interest rate scenario, the principal outstanding will decline at a slower pace than in the original schedule
• So, the insurance cover could be less than the principal outstanding, leaving the borrower’s successors exposed
• In case of HLPP, if you paid a single premium, recovering the premium will be difficult if you pay off the loan, or switch