Home Loan Insurance – why do banks insist on bundling it with the home loan? Why is it required? Is it the best way to do the job or is there anything better? We will answer these all questions and tell you the best approach that you should follow when closing on your dream home.
Buying a home is a dream of every middle-class person. People save all their life to first pay the downpayment and then the EMIs of their home loan. Buying and entering one own home for the first time (“Griha Pravesh” in India). However, many people do the cardinal mistake of skimping out on home loan insurance when taking that home loan and some people pay for it dearly.
What is Home Loan Insurance?
Home Loan insurance is basically an insurance policy against the home loan so that in case a person faces an eventuality, the loan can be paid off with the policy proceeds. Depending on the policy riders, it can cover death, disability, temporary relief in case of job loss, etc. As you increase the number of riders the premium also increases.
The premium of the policy can either be done at regular intervals or at one go (Single premium). Single premium towards home loan insurance can often be clubbed with the home loan and paid by the bank in return for a slightly higher EMI.
Why is Home Loan Insurance required?
What generally happens in case of a home loan?
- It is repaid by the earning member or the savings of the family
- People are unable to repay because of no savings and
- Death of the earning member
- Disability of the earning member
- Job loss
- Other reasons
If everything goes according to plan and the loan is repaid by the expected source of income, then things are ok. However, if it is not repaid the banks will most likely repossess the home and the family is out of their dream home. Even if the family pays it from the savings it would be a huge burden and financial plans would most likely be shattered.
Hence, this saying is apt in this particular case, where a family purchases a house by taking a home loan but in order to secure their future against any eventuality they must take home loan insurance so that in case of any eventuality they are covered.
How does it work out?
When banks give out home loans, they often try to club it with Home loan protection plans (HLPP) in a single premium fashion, and that premium is clubbed with the total loan amount EMIs increase slightly. In case of any eventuality covered in the insurance policy, the remaining loan is paid through the policy, and the EMIs stop.
Is there a better way?
A better way according to me is to buy term insurance or increase term insurance when you buy a home. For example, if you have purchased a home with a loan amount of 80L, my recommendation would be to buy an additional term plan for 80L on an annual premium. If you want additional riders like disability or severe illness cover, these can also be taken along with the term plan.
Now let’s discuss how is term plan better than Home loan protection plans offered by the banks
While the Home loan protection plan covers only the remaining part of the loan, the term plan will keep on covering the entire amount – 80L in the above example. Hence, the coverage in the term plan would be higher as we move forward. In case of an eventuality, the balance of the loan amount can be paid and the rest of the proceeds from the term plan can be utilized for other purposes.
An argument can be made that the costs (premium) also might be higher, but that’s not always true for a good investor.
Costs – Premium and its frequency
Generally, HLPP would be offered with a single premium of a lump sum amount that will get added to the loan amount and EMIs can be serviced. However, term plans are generally annual installments and therefore the initial payments are lower in a term plan.
This difference can be invested to get good returns against the additional EMIs that you will pay in case of HLPP
Banks push for HLPP because they get good commissions from the insurance companies on selling these plans. Additionally, if you buy term plans from outside you can also compare among the plans and get the best deal which might not be possible with HLPP from the bank because they might have a single tie-up.
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This is probably the biggest difference and the best argument in favor of a term plan. Since normal home loan insurance is tied to the loan, there are a lot of restrictions on it.
People who take home loans generally either:
- Repay it sooner and hence tenure decreases – prepayments don’t attract penalty and repaying it sooner is generally advisable if you are not an avid investor and you get a lower return from the capital elsewhere compared to the interest you pay on a home loan.
In this case, you don’t get any benefit in premium because of the lower than planned outstanding loan
- Increasing the tenure because of difficulties in timely payments – Many times, people are not able to service home loan EMIs because of income fluctuation or because of unexpected expenses. In those cases, there is a chance they may increase the tenure and decrease their EMIs. However, the home loan insurance might not be flexible and may not cover the entire outstanding going forward if the tenure is increased.
- Balance transfer – Banks are also commercial entities and work for a profit. Indians have an inherent belief in the banking system and they think that they all follow all regulations and are looking out for the benefit of the common man. Now, while this might be true for some institutions but is certainly not for most. Loans, especially home loans are a great example.
Most banks will increase the interest rates automatically whenever RBI increases the rates, however, will not decrease it automatically when RBI decreases them. Hence, unsuspecting borrowers are stuck paying EMIs at higher rates when essentially they should have been paying lower EMIs.
Many people are now become aware of this dichotomy and are also comparing the rates among several banks and are opting to transfer their loans in case they get better rates at a different bank.
Now in the case of this balance transfer, the home loan insurance might not be flexible to cover the loan at the new bank. In such a case, the premium might be wasted or worse if this doesn’t let you think about switching then you might lose much more in the long run
Always buy an insurance cover to safeguard your family when taking a home loan or in fact any large loan or liability. In the case of a home loan, it is generally better to buy a term plan for the loan amount because of the flexibility it offers.
So, compare the term plan (with relevant riders) from the providers and get the best one. Also, congratulations on your dream home.
Do note that Property or Home insurance is not the same as Home Loan insurance. While Home loan insurance is important, property or home insurance is also important and it is not an either-or situation.
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