Buying insurance cover with home loan is not mandatory.
But still, banks “insist” the borrower to avail this facility.
What one must do?
If buying insurance cover with home loan is not mandatory, then why the lender (banks) insist on it?
There are banks who may not even accept the home loan application without insurance cover. Why?
Buying insurance cover with home loan does not come free. It has a cost.
A person who is taking home loan, will already bear the extra load of EMI’s from next months.
The cost of EMI’s are anyways tough to manage. To top it all, banks insist on buying insurance cover.
It’s not a surprise why, so many prefer to opt-out of the insurance cover.
#1. Why people resist insurance cover?
A person who is availing a home loan, his/her monthly committed cost goes up by at least 30%.
Generally speaking, if a person is spending Rs.100,000 per month today, after home loan, this cost will shoot up to at least Rs.1,30,000.
This is a cost increase by 30%.
And this additional cost, will be incurred each month, for next 10-15 years.
This is why, EMI’s creates a huge financial and psychological load on the borrower.
Amidst the happiness of buying a new home for self, this cost-hike comes like a trauma.
In this state of trauma, even fractional “additional-costs” becomes psychologically unbearable.
[How much is the additional cost? We will see in #4 below]
Buying insurance cover with home loan is an example of additional-cost.
Though this additional cost is not so high, but ones psychological-bottleneck overcomes the benefits of insurance.
#2. The Benefit of Insurance Cover offered with Home Loan?
There are two beneficiaries of such an insurance cover:
- The Lender (like Banks).
- The Borrower (like us).
#2.1 Benefit for the lender:
Bank finance our home purchase. They pay the money to the seller/builder on our behalf.
In turn, the seller/builder sells the property to the buyer.
But banks does this with an assumption that, the buyer will pay back the loan/debt in form of Equal Monthly Instalments (EMI).
What happens if the EMI stops?
The reason? Example: The borrower passing away in a road accident.
In such a condition, the bank cannot get the due EMI. What happens to the issued loan?
Banks call such home loan as “Bad Debts”.
No Bank would like to incur a bad debt.
Had the borrower bought insurance cover with the home loan, bank would not have made a loss due to bad debt.
The outstanding balance of the home loan, could be cashed-in from the death benefit received from the insurance cover.
#2.2 Benefit for the borrower:
We have seen what happens to the banks when EMI stops.
But what is the effect of non-payment of home loan EMI on the borrower?
In case of demise of the main borrower, the responsibility of payment of EMI’s falls on the deceased’s family.
If the family is able to afford the EMI payment, problem is resolved.
But in most cases, the situation is much worse. The family cannot pay the EMI’s.
In such a case, the bank has authority to ask family to vacate the property.
It means, if EMI’s are not paid, the family is forced to go homeless.
Had the borrower bought insurance cover with the home loan, family would not be rendered homeless.
The outstanding balance of the home loan, could be cashed-in, from the death benefit received from the insurance cover.
Banks will have their share of outstanding loan balance.
The family will continue to live in the same home.
#3. “Property Insurance Plan” and “Home Loan Insurance Plan” are not same…
While one is availing a home loan, they will come across two types of insurance cover:
- Property insurance.
- Home Loan Insurance.
#3.1 Home loan insurance plans
They are easier to understand.
As the name suggests, this insurance plan covers only the “home loan”.
In case the borrower is not able to pay the home loan dues, “home loan insurance plan” will clear the dues.
The cause of non-payment of home EMI’s can be:
- Loss of life.
- Loss of income (job/business).
- Physical disability leading to loss of income.
- Etc.
#3.2 Property insurance plans
Property insurance has a difference scope to cover.
Damage to property arising due to the following, will be covered here:
- Accidental fire, explosion etc.
- Burglary leading to theft and losses.
- Etc.
Property insurance purchase is also not mandatory in India as on today.
But in a way, both insurance plans are important.
If the borrower can afford, he/she must take both.
Why I am highlighting this difference here?
People often confuse between these two insurance plans.
I have seen people buying property insurance, wrongly assuming it to be home loan insurance.
Please do not confuse.
“Home Loan insurance” and “property insurance” are different products.
#4. Digging deeper into “Home Loan Insurance Plan”…
We have discussed that, home loan insurance cover is an additional cost for the borrower.
Due to this additional cost, people often refrain from buying insurance cover offered with home loan.
But how much is the additional cost? What is the structure of this cost?
#4.1 “Single Premium” Term Insurance Plan (SP.TIP)
Do not bother to remember the acronym (SP.TIP).
- SP : Single Premium.
- TIP: Term Insurance Plan.
I have just included to make it easier to remember.
Why we must remember this?
Because while one goes for home loan, banks will bombard you with this jargon called “Single Premium Insurance”.
Two things to be understood here:
- What means by Single Premium Insurance? and,
- Why only Term Insurance Plan, and not endowment plan?
#4.2 Single Premium Insurance
You must have bought a life insurance policy, right?
How you pay its premium? In most cases, annually.
This is called “multiple premium” insurance, where premiums are paid every year, till maturity.
In “single premium” insurance, the premium is paid only once. Up front, in the first month itself.
How banks offer home loan insurance to the borrower?
They will first pay the “single premium” amount to the insurance company on your behalf.
This way you get the home loan insurance cover.
But how the bank recovers the cost of single premium from the borrower?
They add the single premium amount to the home loan. Then accordingly, increase the monthly EMI of the home loan.
Example:
- Home loan amount: Rs.50,00,000.
- Loan Tenure: 20 Years.
- Home Loan Interest: 8.5% p.a.
- EMI (without insurance): Rs.43,400
- Borrower’s Age: 30 Years.
- Annual Insurance Premium: Rs.4,000.
- Total Premium to be paid in 20 years : Rs.80,000 (4000 x 20)
- Single Premium: Rs. 56,000 (approx. 70% of above)
- EMI (with insurance): Rs.43,900
- Increase in EMI due to insurance: Rs.500 per month.
Due to the single premium, the EMI of the borrower goes up by Rs.500 (Rs.43,400 to Rs.43,900).
What’s the point?
Had the bank not paid the single premium on your behalf, the borrower would had to pay Rs.56,000 from his pocket.
But now, the borrower will pay only Rs.500 extra each month.
Rs.500 per month vs Rs.56,000 lump sum, which is more convenient?
I am sure majority will opt for Rs.500 pro-rata cost.
#4.3 Why Term Insurance Plan?
Because term insurance provides the “least-cost” life cover.
In case of death of the policyholder during the policy term, applicable death benefit is payable to the beneficiary.
[Note: Here the beneficiary can be the lender or a family member.]
But there are no maturity benefits in term insurance plans.
As there are no maturity benefits, term insurance plans provides the cheapest life cover.
In other words we can say that, term plans are pure insurance product without any investment component.
Endowment plans come with investment component. Hence they are costlier than term plans.
Here in case of home loan insurance, the priority is not investment.
The borrower needs only “home loan amount protection” against any possible future mishap.
Hence term plan is most suitable.
#5. Practical Suggestions for the borrower…
So this is all theory, right? What actually the borrower must do?
Consider this, you want to take home loan from your preferred bank X. But the bank is insisting on home loan insurance.
What you can do?
#5.1 Tell to yourself that home loan insurance is necessary.
Yes, this is what we discussed in #2.2 above, right?
It is also essential to remember that, home loan must be protected.
I am not suggesting you to go ahead and buy the insurance cover offered along with the home loan.
Probable it is not the best available option.
What is the better alternative? Buy a term plan yourself, separately from home loan.
Why to do this?
To understand the cost difference.
#5.1 Compare the costs.
An independently bought term plan will cost you slightly lesser.
How to know this?
Ask your bank to give you quote for EMI (with and without home loan insurance).
You can approach independently an insurance company, and show them the below values:
- Home loan amount: Rs.XXX.
- Loan Tenure: XX Years.
- Your Age: XX Years.
Ask them to give you a quote as following:
- Single Premium: Rs.YYY
- Annual Premium: Rs.YYY
- Monthly Premium: Rs.YYY
Now compare the below values:
- Home Loan EMI (without insurance).
- Home Loan EMI (with insurance).
- Difference between 1 & 2
- Quote of Monthly Premium received separately from insurance company.
If 4 less than 3, it means an independently bought term plan is better.
#5.2 Calculate 80C benefit of buying an independent term plan
Yes, independent term plan can save you income tax u/s 80C.
This is another benefit of buying a separate term plan, independent from home loan.
When term plans are embedded into the home loan (home loan insurance plans), the borrower cannot claim 80C benefits.
Though, I must say that this savings will be very minimal, but one must do this calculation to quantify the “additional cost”.
#5.3 What if one already has a life cover?
This is a very good case to study.
Suppose the borrower already has a term plan with a cover of Rs.1.0 Crore.
He is buying a home, with home loan component of Rs.50 Lakhs.
What he must do? Should he buy additional life cover?
Sure, he must buy an additional life cover.
Better will be to top-up the existing life cover of Rs.1.0 Crore with another Rs.50 Lakhs.
Now the borrower will have a total life cover of Rs.1.5 crore.
In case of any mishap, the family will receive Rs.1.5 Crore from the insurer.
- Rs.1.0 Crore to be kept by the family.
- Balance (like Rs.50 Lakhs) to be used for clearing the outstanding loan balance
Conclusion….
As per rules, banks or any financial institution cannot compel the borrower in buying insurance cover with home loan.
Though this is also true that, home loan insurance plan benefits both the lender and the borrower.
But the cost for this insurance cover is generally born by the borrower.
But it will not be a bad idea to ask the lender (bank) to distribute this cost 50:50.
One can also try some arm twisting with the bankers.
Politely make them aware that you know the rules that, purchasing insurance cover with home loan is not mandatory in India.
You can also go a step further.
Ask the Bank officials to give you an appointment to meet their higher officials (like Bank Manager).
Tell them that you have the option to contact the Banking Ombudsman.
Final Words…
But having said that, the borrower must also think internally.
How important it is to maintain a home loan insurance?
What happens to the home, in case of demise of the main borrower?
How prepared will be the family to pay the EMIs (clear outstanding home loan balance) after the demise of the main borrower?
Frankly speaking agreeing for a slight extra cost of few hundred Rupees per month, to get a life long security for the family is not a bad idea.
Buying a insurance cover for home loan protection is a wise move.
Sufficient care must be taken while taking home loan.
Loan is a liability.
A liability is like double edged sword. Hence one must protect self from liabilities.
Of course, this must be done within the boundary of ones affordability.
