Without proper loan insurance, you could lose your house

The policy must insure the breadwinner’s life. Other covers can at best be add-ons

Many families have lost their breadwinners during the Covid pandemic. Those that had taken a large home loan without purchasing an insurance policy to cover this liability are staring at the risk of losing their house. Even worse is the plight of families that had purchased a cover but are still not being compensated. The reason: The breadwinner had—either due to mis-selling or oversight—bought a policy that does not cover death.

Avoid wrong covers

Many types of policies are sold under the moniker “loan protector cover”. General insurers, for instance, sell policies that pay up if the insured contracts one of the named critical illnesses, meets with a personal accident, suffers disability or job loss. Different policies may cover different permutations and combinations of these risks.

Sometimes, property insurance, which covers the building and its possessions against risks like fire, natural calamities, etc. is mis-sold with a loan.

Borrowers should not go by the name of the policy. They must understand what it covers. “The primary risk here is that of the insured losing his life and his family being unable to pay the equated monthly instalments (EMIS). This risk can be covered only by purchasing a life policy,” says Gaurav Gupta, founder and chief executive officer (CEO), Myloancare.in. Policies that cover critical illnesses, personal accident, etc. can at best be add-ons.

The home loan borrower should choose from one of these three policy types:

Group home protection cover: This policy is also referred to as group credit shield. It is issued by life insurers and covers the borrower’s life. This is the policy usually pushed by lenders at borrowers (where no mis-selling is taking place). The lender is the beneficiary here: Any payout made goes towards settling the loan, and not to the borrower’s nominee. In case the borrower dies, the loan is settled without the family having to do anything.

However, it has quite a few disadvantages. The family doesn’t have any say in what to do with the money.

These are single-premium plans. Often, a borrower takes a loan for 20 years but repays it within seven. The policy lapses once the loan is closed and the premium for the balance years goes waste. If a borrower switches from one lender to another, then, too, the cover lapses.

Individual home protection cover: This is the individual version of the policy described above. It is less commonly available than the group cover. “Here, the borrower, and not the lender, is the principal. Even if the borrower switches from one bank to another, his cover continues,” says Gupta. This type of policy may cost more than the group cover. Individual term cover: This is the pure life cover one buys from a life insurer to guard one’s family against the risk of the breadwinner’s premature demise. Experts say a term plan bought independently, and not from the lender, after comparing premiums and features works best.

Here, the nominee receives the payout and can decide how to use the money. “If the spouse earns, she may be in a position to continue paying the EMI. She may then invest the money from the policy to achieve the other financial goals of the family,” says Adhil Shetty, CEO, Bankbazaar.

The annual premium imposes a lower burden. A group cover is a single premium policy. Borrowers often have to take a second loan from the lender to pay the large single premium. And if the borrower pre-pays the loan, he can terminate his term policy without any loss of premium.

“Borrowers should supplement the term cover with a personal accident and disability policy,” suggests Shetty. A term plan has one downside, however. “The borrower has to undergo medical tests. This is not required in a group cover,” says Kapil Mehta, co-founder and managing director, Secure Now Insurance Broker. Those who fail to meet the underwriting standards of a term cover may opt for a group cover.

Don’t fall prey to coercion

One unseemly aspect of taking a home loan is that the lender often coerces the borrower into buying an insurance cover. Sometimes, the lender’s representative even threatens that the loan will be withheld. “The regulators frown upon such forced cross-selling,” says Mehta. If the lender insists, ask it to give you in writing that loan approval is contingent on the purchase of a policy. Most will back off.

Lenders announce special rates during the festival season. Those rates are offered only to borrowers who buy a policy. “Pay the 10 to 15-basis-point higher interest rate but opt for a term policy purchased independently due to the greater flexibility it offers,” says Gupta.

Constant or reducing cover?

The group covers sold by lenders offer both options. With a constant cover, any money left over after repaying the loan goes to the family. In a reducing cover, the sum insured declines in line with the fall in principal outstanding as the loan is paid. This policy type is cheaper.

But there is one nuance borrowers should be aware of. The sum insured decreases in line with the original repayment schedule. If interest rate rises, the lender keeps the EMI unchanged and increases the tenure. “Now, you repay the principal at a slower pace, but the cover falls in line with the original schedule. The borrower risks becoming underinsured,” says Deepesh Raghaw, founder, Personal finance plan, a Securities and Exchange Board of India-registered investment advisor. The constant cover thus provides greater safety.