An Home Loan Protection Plan repays the outstanding loan if the borrower dies or suffers a covered disability.
Key Points
- RBI has barred lenders from forcing borrowers to buy third-party insurance products bundled with home loans.
- Home loan protection plans repay outstanding loans upon death or disability but offer limited financial flexibility.
- Term insurance plans provide broader financial protection and remain unaffected by loan transfers or prepayments.
- Borrowers using HLPP may pay additional interest if the insurance premium is financed through the loan.
- Experts suggest aligning insurance coverage with both loan obligations and broader family financial goals.
The Reserve Bank of India has strengthened borrower protection by barring lenders from compulsorily bundling loans with third-party products.
This malpractice has been rampant in home loans and the insurance covers sold along with them.
The guidelines require lenders to obtain explicit customer consent, allow borrowers to choose their insurer, and compensate them in proven cases of mis-selling.
With the regulator extending the scope of protection offered to borrowers, it is up to the latter now to make the right purchase decision.
A key question they must answer is whether to go for a home loan protection plan (HLPP) or a term insurance plan to cover the loan amount.
How an HLPP works
An HLPP repays the outstanding loan if the borrower dies or suffers a covered disability. Insurers commonly sell these policies as single-premium plans.
Pros: An HLPP offers convenience. The borrower usually pays the premium as a one-time lump sum and does not have to worry about recurring premium payments.
"The premium can be bundled into the main loan amount," says Abhishek Kumar, Sebi-registered investment advisor and founder, SahajMoney.com.
This means borrowers do not have to pay the premium upfront from their own pocket.
"These mortgage redemption plans are group plans. Also, their sum insured keeps decreasing as the EMIs are paid and the principal outstanding reduces," says Shilpa Arora, co-founder and chief operating officer, Insurance Samadhan.
Both these factors make the premium rates of these plans more affordable.
Group plans usually have a simpler underwriting process. "The medical examination requirements are typically less stringent than those of standalone life insurance plans," says Kumar.
Cons: Adding the premium to the principal means the latter amount increases. "The borrower pays extra interest on the insurance premium for the entire loan tenor," says Kumar.
An HLPP only clears the home loan debt. It does not leave surplus money for the family's living expenses or other goals.
How a term plan works
Borrowers can also cover their home loan by buying a pure term insurance plan.
Pros: A term plan offers greater flexibility because it is tied to the individual, not the loan.
"Even if the borrower prepays the loan or transfers it to another bank, the term plan remains unaffected," says Kumar.
"The nominee can receive the money directly and can use the funds as deemed suitable," adds Narendra Bharindwal, president, Insurance Brokers Association of India.
A term plan can protect the family's broader financial needs and goals, instead of covering only one liability -- the home loan.
For a Rs 1 crore sum assured, a 35-year-old male based in Mumbai would pay a premium of around Rs 13,000 to Rs 14,000 for a term plan.
Cons: The key limitation here is that borrowers cannot finance the premium of a term plan. "They must pay the premium separately out of their own pocket," says Kumar.
What should borrowers do
While HLPP may be more economical, individual term plans offer greater flexibility.
"One option could be to use an HLPP to cover the home loan, and a term plan to cover the family's other liabilities and financial goals," says Kumar.
For those who prefer to buy a term plan to cover the home loan, Arora suggests buying two plans instead of one with a high sum assured.
"If the loan amount is Rs 40 lakh, buy one plan for Rs 40 lakh and assign it to the lender. The other term plan should be assigned to the family," says Arora.
Borrowers should pay attention to policy tenor if buying a term plan. The tenor should be slightly higher than the loan tenor.
"Home loans usually run on floating rates. Rising rates can stretch the tenor beyond the original schedule. Buying insurance for a few years beyond the original loan term can safeguard against tenor extension," says Sarvesh Kumar Mishra, chief third party distribution officer, Generali Central Life Insurance.
Despite what the regulator has said, watch out for loan executives who claim that loan approval or interest-rate concession depends on buying insurance through the lender's preferred insurance provider.
Disclaimer: This article is meant for information purposes only. This article and information do not constitute a distribution, an endorsement, an investment advice, an offer to buy or sell or the solicitation of an offer to buy or sell any securities/schemes or any other financial products/investment products mentioned in this article to influence the opinion or behaviour of the investors/recipients.
Any use of the information/any investment and investment related decisions of the investors/recipients are at their sole discretion and risk. Any advice herein is made on a general basis and does not take into account the specific investment objectives of the specific person or group of persons. Opinions expressed herein are subject to change without notice.
Feature Presentation: Aslam Hunani/Rediff
