Home loan cover from the lender may not be the best option
When taking a home loan, lenders usually force borrowers to take an insurance cover from them. This helps them to recover the outstanding in case the borrower passes away and they also earn a handsome commission. But the home loan cover from the lender may not be the best option. There are other policies that can give more benefits at lower costs. And these work out to be more cost effective for young borrowers.
Cover from a general insurer
In the event of the borrower's demise, these covers automatically pay up the entire loan amount that is outstanding at the time of death. Some of these insurance covers also pay the equated monthly instalment (EMI) for up to three months in case the insured loses his job. The premium for these policies is usually a single upfront payment.
Most lenders add the premium paid on these policies to the loan amount and accordingly increase the EMI. In fact, they are keen that borrowers buy this cover so that they are safeguarded against a default. Remember that when you buy this policy you pay interest on the insurance premium as well, which adds to the cost of the policy.
Statistics show that most home loans get repaid in less than 70 per cent of their total tenure. However, the one-time premium a person pays is on the original value of the loan. When you pre-pay the home loan and close it ahead of schedule, a substantial portion of the insurance cover remains unutilised and a good portion of the premium paid goes waste. All this adds to the cost of your home loan.
Instead of opting for this single-premium home loan insurance, there are other cheaper options you can go for.
Personal accident cover
Home loans are typically given to the salaried who are young enough to be able to repay the loan before they retire. The likelihood of a relatively young person passing away due to natural causes is low, but his chances of having an accident are relatively high.
An accident seldom leads to death, but it often causes injury, sometimes of a serious nature. This in turn leads to temporary or permanent loss of income, which affects the person's ability to repay his home loan.
The ideal insurance cover for guarding against this risk is the personal accident policy. It covers the insured against loss of limbs and paralysis. These policies also provide for payment over and above the sum assured in the event of serious injury or death due to an accident.
While general insurance companies offer this as a standalone cover, life insurance firms can only offer it as add-on or rider. The sum assured calculated based on the borrower's income.
The premium of these policies is very low. They provide a cost-effective cover against both death and serious injury. The payout received from this policy can be used by the insured to cover several needs, including to pay off (at least a part) of the home loan outstanding. In fact, personal accident insurance is an excellent cover for everyone, irrespective of whether or not they have taken a home or any other loan.
Term cover: the best option
To cover the liability for the entire home loan and get the best possible value for the money paid, opt for a term insurance cover. When you are trying to determine how much sum assured you need, it is important to take into account all the loans you have taken.
When you buy a term insurance from a life insurance company, you pay an annual premium. Unlike a home loan cover from a general insurer, you don't pay the entire premium upfront.
Unlike home loan insurance, term plan offers level coverage. This means that the sum assured does not diminish as the principal outstanding reduces (due to the payment of EMIs). However, you should not worry about the extra cover that you have from a term cover.
As a person's family and income grow with time, the amount of insurance cover he needs also grows. Therefore, while a term plan protects the family against outstanding mortgage, the remainder of the insurance cover can be useful in covering the growing insurance needs of the family.
The best part about using a term policy to cover your home loan liability is that you can simply discontinue it when you don't need it by not paying the premium on the policy. A person should ideally do so at the time of retirement, provided he has managed to meet all his financial goals by then.
All home loan borrowers should use a mix of term cover and personal accident cover, both of which are very simple products. The term insurance cover will take care of the home loan liability and also provide for the family's other financial needs.
The personal accident cover will guard against loss of income due to injury, and also against death, and is a must-have policy, irrespective of whether one has taken a home loan.
As the breadwinner, once you have bought an insurance cover against the home loan, you can be rest assured that the asset you have purchased will stay with the family under all circumstances. And, you can accomplish it at only a small additional cost.
Anil Rego is CEO and founder, Right Horizons
Photograph: Mike Blake/Reuters