This insurance helps fulfil the basic purpose of buying a house—that of taking care of the family, more so in your absence.
In the books of financiers, home loan is considered to be one of the safest debts. A home loan is fully backed by a collateral, which is 20 to 25 per cent higher in market value. Further, the quantum of loan to be sanctioned is ascertained based on the income-generating ability of the borrower and not the underlying asset. The latter is true for commercial loans. Due to their low-risk profile, home loans are charged the lowest interest rates. However lenders have realized that when they look at the broader picture, i.e., the entire book, a certain proportion of loans end up as defaults because of the borrower’s death. Banks can take possession of the property to recover the principal amount. However, selling a real estate asset is a long-drawn process. To circumvent this, banks recommend that their borrowers buy life insurance. The question is whether this is good for the borrower as well.
Insuring home loans
The term insurance attached with loan products is commonly referred to as Credit Shield. The standard version of such a product is a single premium plan. The plan is of the same duration as the loan term. The sum assured is equal to the loan amount. Generally, the coverage is based on a reducing sum assured linked to the reduction in loan principal amount. The claim amount is paid to the bank, as an assignee of the policy. Some insurers settle the claim amount in favour of the loan account of the borrower. The premium is paid as a lump-sum to the insurer. It gets added to the total loan amount, and is then recovered from the borrower via the EMI (equated monthly instalment). If you examine this carefully, you’ll notice that the design of the plan is primarily to protect the lender’s interest. So, there is hardly a residual amount left for the borrower’s family.
Credit shield coverage cannot substitute for a term insurance. However, on a standalone basis, the biggest advantage of credit shield is its ease of administration: Issuance rates are high, and the borrower rarely has to undergo a medical check-up. At the time of the claim, the borrower’s family has to complete only limited paperwork, and the bank directly coordinates with the insurer. The principal disadvantage however is the cost. Some banks have tie-ups with insurers offering expensive plans. When this premium is recovered upfront, the borrower has to pay high premiums and interest on top of that.
Some NBFCs do offer a few product options to the borrower. These include flat sum assured and reducing sum assured. Insurers have started differentiate their offerings by including riders for accidental death, disability and critical illness. A few plans offer the flexibility of covering joint life, i.e., the spouse of the borrower could be covered in the same plan. Given that the overall sum assured of the credit shield is low, we recommend avoiding the add-ons. Instead, you should buy standalone comprehensive plans for these covers.
Enhance your cover
For term life, the recommended sum assured for an individual is about ten times her annual income. This should be enhanced further for any known financial liability such as a loan, or planned expenditure such as child’s marriage. When buying a term insurance, it is a good practice to opt for an insurer with more than 90 per cent claim settlement track record. The core coverage of term insurance is the same across insurers. The only exclusion allowed is suicide in the first year. You can choose the cheapest plan that meets the above criteria. Some plans offer an additional terminal illness cover within the same premium. Buy the term insurance at a young age. The premium is low then, and gets locked for the term of the plan. So, the sooner you buy, the better it is for you. For a 40-year-old, looking for a coverage of Rs 1 crore till the age of 60, the premium works out to around Rs 10,000 plus taxes.
If you already have a term cover to take care of your family expenses and liabilities, you could opt-out of the credit shield product. In your existing plan, you can do a partial assignment of the proceeds in favour of the bank. This will suffice for the risk concerns of the bank and will be cost-efficient for you. In case, you do not have a term cover or the coverage is inadequate, you can opt for the credit shield product. Choose a regular premium paying product over a single premium one. You will be able to discontinue this in case the loan is pre-paid.
Young home buyers in the age group of 25 to 35, often have an air of invincibility. Life, however, is unpredictable. While the average life expectancy goes well past the loan term, some unfortunately die at a young age. We understand that insurance is an additional cost, over and above the expensive house and it’s and associated loan costs. However, just like banks take a broader picture to hedge their portfolio, borrowers should develop a similar perspective. Insurance helps fulfil the basic purpose of buying a house—that of taking care of the family, more so in your absence.
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