[ecis2016.org] We look at why home buyers should buy a separate life insurance policy to cover the home loan liability and how to go about it
The amount of home loan availed of to buy a house generally constitutes a significant portion of the monthly income of the household. If something happens to the bread-winner, it becomes almost impossible for the family to run the household, leave aside being able to service the home loan in such a situation. It is almost impossible to pay off a huge home loan amount from one’s savings, especially during the initial years of the tenure.
You are reading: Why should you buy a life insurance to cover your home loan
Why is life insurance policy needed to cover the home loan?
As a basic principle of financial planning, experts advise their clients to buy life insurance, to cover all their financial liabilities. When you take a home loan, a new financial liability comes into existence. Taking a life insurance policy to cover the home loan liability, will ensure that the legal heirs inherit the house and not the home loan liability. In the eventuality of death, the insurance company pays the lender the outstanding loan amount. This helps the dependent family members to avoid the pain of losing the house. This life insurance policy should be over and above the regular life insurance cover that you may have already bought, to cover your other financial obligations, to protect your family members in case anything happens to you.
Do you have to buy the home loan protection plans from the same home loan lender?
Neither the banking regulations, nor any other law, mandate that the home loan borrower has to buy a life insurance policy to cover the home loan. However, in order to avoid the hassle of taking possession of the property and having to auction it, to recover the outstanding home loan amount, lenders generally insist that the borrower buy a term plan to cover the home loan. Moreover, as most of the banks that provide home loans either have their life insurance associates or have arrangements with some life insurance companies to sell their product to enhance their income, these lenders also insist that the life insurance policy be bought through them, which is not mandatory for you.
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Since the term plan is a simple product, the basic offerings of different insurance companies are generally similar. So, you can refuse to oblige the lender if the life insurance policy offered by your lender is not the cheapest. If the lender still insists you to buy the insurance product from them, you can ask them to furnish, in writing that it is mandatory to buy the life insurance policy from them as a precondition for giving you the home loan. Since the lender cannot give this to you it in writing, they will agree even if you buy a life insurance policy from another insurance company and assign it to them.
How to buy life insurance policy to cover a home loan?
A basic advice that financial planners give, is never to mix insurance and investment and to buy a term plan life insurance policy only and not to go for any other insurance product. This advice applies here, as well. If you are tech-savvy, you can buy an online term plan directly from the life insurance company, without involving any insurance advisor. Online term plans are cheaper by around 25%-35%, as compared to regular term plans with no difference in the product. This is because the life insurance company does not have to incur the expenses of commission and marketing of the product.
The tenure of the life insurance policy to be bought for this purpose, should be equal to the tenure of the home loan.
Lenders generally insist on single-premium term plan policies, which are tailor-made for home loans, where the amount of insurance premium is recovered upfront and is included in the home loan. This component of life insurance premium is recovered from you over the tenure of the home loan, through enhanced EMIs. However, I would advise against buying a single premium policy. Instead, opt for an annual premium payment policy, where you can discontinue the life insurance policy any time when you want. This is because, in most cases, home loan borrowers do not run their home loan for its entire tenure but generally prepay the home loan to become debt-free, as and when they accumulate enough funds. In such a situation, the portion of premium already paid under the single-premium policy goes down the drain, because the insurance policy either may terminate or may run when there is no corresponding liability outstanding for which it was purchased. Some life insurance companies offer term plans, where the insurance amount gets reduced, in line with the outstanding home loan amount. In case you are able to get such a reducing insurance policy, you should opt for the same. This will make your life insurance cheaper and more affordable.
(The author is a tax and investment expert, with 35 years’ experience)
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