How to Dream Home Loan Protection Plan

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How to Dream Home Loan Protection Plan

 

You are planning to buy your dream home. You have approached various banks to get the best deal on home loan interest rates and other processing charges. After much hard work, you have finalized a bank. During a visit to the bank to complete formalities, the bank official told you it is compulsory to purchase a home loan protection plan (home loan insurance) to avail the loan. You were not prepared for this extra expense. You were politely told that you need not worry and that you will not have to pay anything right now. The premium amount would be added to your loan amount. You decide to find out more about home loan protection plans and ask the bank official to hold for a while.

 

What Are Home Loan Protection Plans?

 

Home Loan Protection Plan (HLPP) is an insurance plan. Under this plan, insurance company settles any outstanding amount on the home loan with the bank/lender in the event of death of the borrower. The policy term is usually the same as the loan tenure. This way, a borrower can ensure that his/her family will not have to vacate the house due to non-repayment of home loan after demise of the borrower.

Please note a Home Loan Protection Plan is different from property/home insurance. Under property insurance, you purchase cover against risks to property/home due to earthquake, fire, flood, storm, theft etc.  Home/property insurance can be mandatory at times. If such is the case, it will be clearly mentioned in the home loan agreement.

Home Loan Protection Plan, on the other hand, is simply to guard against the risk of default on home loan in the event of death of the borrower. In the event of death of the borrower during the loan tenure, the insurance company will settle the outstanding loan with the bank. It is not mandatory to purchase home loan protection plans.

The policy could lapse on full repayment of loan or after demise of the borrower or on transfer of loan to another bank. Some policies will continue till the end of the chosen policy term even if the loan has been repaid. (Ex: ICICI Pru Loan Protect). With such policies, the life cover and the policy period will vary from the loan’s outstanding principal and loan tenor. Both general and life insurance companies provide HLPPs.

 

Types Of Home Loan Protection Plans

Three Type Of Home Loan Protection Plan

 

  1. Reducing cover option:  Under this plan, the life cover reduces similar to (but may not be same as) loan repayment schedule i.e., the life cover goes down just like your loan’s outstanding principal. At any point in time, your life cover is greater than your outstanding loan principal.
  2. Level Cover (aka Fixed Cover) Option: Under this plan, life cover remains constant for the term of the plan.
  3. Fixed Cover for a years followed by reducing cover for the remaining years

Since the risk taken by insurance company is higher in case of level cover option, the premium for level cover option will be higher than reducing cover option. Most plans provide reducing option only. Hence, depending upon the lender you approach for loan, you may not even have the choice of level option. Particular plans may have optional riders such as job loss (3 EMIs only), accidental death, disability, critical illness etc. Such riders enhance the scope of insured events by payment of additional premium.

 

Premium Payment

HLPPs are mostly single premium policies. However, there are variants available for regular premium and limited premium payment terms. Under regular premium plans, premium payment term is same as policy term. Under limited premium payment plans, premium payment term is less than policy term.

 

HLPPs Are Different From Regular Life Insurance Plans

 

HLPPs are not available in the open market i.e. unlike term insurance plans, you cannot choose HLPP based on fit with your requirements and pocket. These plans are bundled with the home loans taken from banks. The rationale is simple. You need to have a home loan before you purchase such a plan. Bundling of home loan and insurance reduces operational hassles.

The mechanics of a HLPP are slightly different from regular insurance plans. In the event of demise of policy holder, the insurer settles the loan with the bank on policyholder’s behalf. Any excess funds after settling the loan are provided to the nominee of the borrower. For such plans, the insurance company and the bank enter into a master policy agreement for the group insurance plan and the same plan is further extended to bank’s borrowers.

 

The Purchase Of Home Loan Protection Plan Mandatory?

 

No, the purchase of home loan protection plan with home loan has not been made mandatory by law, RBI or IRDA. Even purchase of a term plan is not mandatory. Purchase of an insurance plan is the sole discretion of the buyer and cannot be forced to purchase such plans.

However, banks may have a different policy in this regard to safeguard their interest. If their internal policy mandates the purchase of insurance, it must be mentioned in the loan agreement.

 

Benefits Of Home Loan Protection Plans

 

  • In case of unfortunate demise of the loan borrower, the insurance company settles the loan amount with the lender/bank. The excess amount is paid to the beneficiary of the policy holder.
  • You get tax benefits under Section 80C.
  • You can opt for other riders such as critical illness or disability rider. In such a case, your loan amount is covered not just in case of death but also cases of critical illness or disability. Such riders will increase the premium amount though.
  • A single life cover can cover all the borrowers under a joint loan. You do not need to purchase separate term insurance plan for each borrower.

 

Issues With Home Loan Protection Plans

 

  • HLPPs are expensive as compared to plain vanilla term plans.
  • In case of single premium policy, where you choose to club the premium amount with the loan amount, you will not get any tax benefits for the year under Section 80C as you have not paid the premium (but the bank has). Some HLPPs offer to provide separate receipt for premium payment for 5 years to enable you to claim tax deduction, even though the single premium amount is included with the home loan amount. For example, if single premium of Rs 1,50,000 was included in your loan amount, you will receive premium payment receipts of Rs 30,000 for first 5 years.
  • In case of foreclosure of loan or transfer of loan to another bank, you may lose entire or part of the premium. Different HLPPs have different treatment of such cases. Under a few plans, the risk cover simply ceases with no return of premium. Under other plans, customer’s life cover continues until the end of policy period.
  • Surrender value ranged from 50%-70% of remaining premium (after adjusting for coverage provided on pro-rata basis) for single or limited premium payment plans. Regular payment plans do not have any surrender value. These plans cannot be ported to other lenders (as these plans are under the master policy between the lender and the insurance company). If your single premium was Rs 50,000 for 10 years and you prepay the loan after 4 years, you can surrender your policy to get Rs 15,000 (i.e., (50% X 50,000) X (6 / 10)) back.

 

Why Are Home Loan Protection Plans Expensive?

 

  • HLPP, for banks, is a third party product. HLPP is offered by an insurance company. Hence, commission involved might drive up the insurance premium.
  • Unlike term life insurance, where you can compare and purchase the one with a low premium, HLPPs are not available in the open market. These plans are bundled along with the home loans. And the banks/NBFCs are unlikely to tie-up with more than a few companies. In fact, the banks are likely to stick to their group insurance companies. For example, ICICI Bank may tie-up with only ICICI Prudential and ICICI Lombard. You are a captive customer. Under such cases, there is little competitive pressure.
  • You have already spent so much effort to negotiate the best interest rates. You do not want your effort to go waste because of this extra burden of HLPP premium. Even in case of a single premium plan, the insurance premium is unlikely to exceed 5-10% of the total loan amount. Additionally, you might be under time pressure to close the house purchase deal. The insurance companies and banks are aware of this.
  • Insurance companies follow relaxed underwriting norms for such insurance plans. For example, under ICICI Prudential Loan Protect plan advertised on ICICI Bank website, no medical tests are required for cover up to Rs 3.5 crores for people aged less than 50 years. This relaxation in underwriting norms increases the premium.

 

Term Plan Vs Home Loan Insurance Plan

 

Before we get into any kind of comparison, we need to see why you need life insurance. You need life insurance to ensure that your family does not have to make compromises in life even if you were no longer around. To ensure this, you must have life cover sufficient to cover all your outstanding loans, fund all your important financial goals/life events and provide for your family’s regular expenses. To know more about how to calculate your life insurance requirement, you can read this post.

 

 

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