Is Home Loan Insurance a Wise Decision – Cost, Benefits, Alternatives

What Is Home Loan Insurance

Home loan insurance is often confused with home insurance. But they are totally different things. A home insurance is a policy which you take to cover the risk from of damage to your home and household items. On the other hand a home loan insurance policy ensures that the outstanding loan is repaid in the event of death of the borrower.

Purpose and Benefits of Home Loan Insurance

Home loan insurance is a great concept and it protects the family members of the borrower from the risk of forfeiture of the property in case of untimely death of the borrower and the situation when the family is not in a position to pay their future EMI.

Is Home Loan Insurance a Wise Decision

Most of the housing finance companies and banks prefer that the borrower opts for a home loan insurance scheme. There are two basic reasons behind that.

  • The basic reason is that it reduces the risk of default of non-payment of EMI.
  • And the second reason is that it is an additional source of revenue for them and their subsidiary company which is selling the insurance products.

But should you, as a wise and economically reasonable person, go for a home loan insurance. There is no doubt that protecting the risk of non-payment of EMI in case of untimely death of the borrower is a must. But is home loan insurance the only option? Can we get a better product which serves the purpose and also economical as compared to the home loan insurance?

The answer is yes.

Home Loan Insurance Calculations and Their Alternative

Let us present a case study, and present you some numbers for comparison. Let us take an example and calculate the effect of home loan insurance from HDFC. The online calculator present on their website gives the following result.

home loan insurance premium

Assumptions

  • Age / sex of the borrower = 25 years, male
  • Loan tenure = 15 years
  • Loan amount = 25 lakh
  • Assumed rate of interest = 10%

Calculated results

  • Total one-time premium in case the borrower clubs it with the home loan = Rs. 40,206
  • Total one-time premium in case the borrower pays it from his own pocket = Rs. 39,571

The Alternative to Home Loan Insurance – Term Plan Life Insurance

The other option available with the borrower is to take a term plan life insurance policy. The online calculator for Kotak life insurance policy shows the following.

term insurance premium calculator

  • Sum Assured = Rs. 25 lakh
  • Age, sex of the borrower = 25 years, male
  • The calculated annual premium comes out to be Rs. 3,118.

The back of the envelope calculation can show that an investment of Rs. 23,716 generating returns at the rate of 10% per annum can give you yearly and witty payments of Rs. 3118 for the next 15 years.

home loan insurance not a wise decision

All these calculations mean that if you invest Rs. 23,700 in an investment instrument which generates returns at the rate of 10% per annum, will be sufficient enough to pay for the premium of a term plan life insurance cover which will be equivalent to your home loan insurance scheme.

Here the difference between Rs. 39,571 – which you are going to pay for getting your home loan insurance, and Rs. 23,700 – which is sufficient enough to pay for the premiums for a term life insurance plan equal length to home loan insurance policy, is significant.

This clearly shows that opting for getting a term plan life insurance is much economical and why is the reason than opting for a home loan insurance policy.

More examples showing how term plans are economical than home loan insurance

There is a screenshot from a popular article on the same subject from a leading newspaper website.

home loan insurance vs term life insurance plan

It clearly shows how the annual cost of some of the popular home loan insurance schemes are costlier than the annual premiums required pay for a similar term plan life insurance.

Additional Points to Remember

The comparison doesn’t end here only. Please remember the following.

  1. The risk coverage in case of home loan insurance is restricted only to the principal outstanding balance. This effectively means that the risk coverage goes on decreasing as the outstanding principal balance decreases with each successive EMI payment. On the other hand the risk coverage in case of term life insurance remains the same for the entire loan period. This increased coverage will not only cover the outstanding home loan but could also take care of other financial needs of the borrower’s family in case of his untimely death.
  2. Most of the home loans in India get prepaid at one point of the time or the other. With the increasing salaries and disposable incomes and RBI abolishing the prepayment penalty, the instances of prepayment have only increased. Now, the risk coverage in case of home loan insurance may not be of any use in case you decide to prepay your home loan. Remember, you are required to pay the entire home loan insurance premium upfront right at the beginning. This is not the case with the term insurance, where you are required to pay only on annual basis. In case you are opting to prepay your home loan, you can simply stop paying the annual premiums for the term insurance and your money is saved for the rest of the loan term period.
  3. A similar complexity may arise in case you decide to transfer your home loan to another lender which is offering better loan conditions. Your home loan insurance scheme from the first lender may not be transferred to the next lender and you may be required to take a fresh home loan insurance scheme from next lender. However in case you would have opted for a term life insurance plan from an independent agency, then things would have been much easier.
  4. Yet another issue may come in case of rising interest rates. It is the usual practice to increase the loan tenure without changing the EMI, when the interest rates keep rising. In case of home loan insurance the insurance cover would reduce according to the original loan amortization schedule, however the outstanding loan balance now would be reducing at a slower pace due to extension of the tenure. The overall result will be that some part of your outstanding loan balance would remain uncovered defeating the basic purpose of the home loan insurance. Again this will not be the case with the term life insurance policy.
  5. However some home finance and insurance companies offer home loan risk coverage of against the prospect of losing a job. This scenario is not covered in term life insurance. In this case also, we advise you to go through the riders and fine prints which often restrict the liability of the insurer. For instance in one case the insurance company promises only to pay the EMI is for up to 3 months. In yet another case the insurance company’s liability is served only in case you have been given the pink slip. They will not be paying the future EMI is in case you have quit the job on your own. Besides, this rider can be availed only ones in the lifetime.
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Disclaimer

Lots of approximations and assumptions have been made while developing the calculators.

Please make your own calculations before making any financial decision.