The best way to protect your home loan – home loan insurance or term insurance ?

A home is one of the biggest investments of your life. In most of the cases, investors take a home loan in order to buy the house.

When a home loan is taken, it essentially puts your house on mortgage. The house is owned by the lender as the lender has paid you a loan amount so that you can purchase the property. It continues to stay with the lender till you fully prepay the home loan amount.

But what happens if destiny strikes and you die ? In order for you to leave behind the home for your loved family members, you should have taken some kind of insurance which would ensure that the home stays with your family.

That motive can be achieved by a home loan insurance or term insurance. The former is also called home loan protection plan (HLPP).

The question we have today is which one is more suitable to do the job ?

How does term insurance work ?

When you take a plain vanilla term insurance of a fixed sum assured, you pay a premium each year for the duration of that policy. The fixed sum assured, in this context can be the loan amount which you have taken to buy your house.

If you survive the policy duration, the policy terminates, you lose your premiums and everyone goes home (pun intended) happy.

Should the heavens above generate a liking to you and decide to terminate you and you die, your family members get paid the sum assured from the insurance company. The family members then pay the outstanding loan amount to the lender and make the house is free from the clutches of any bank or housing company. If the outstanding loan amount is less than the sum assured, your family gets to keep the difference.

How does a HLPP work ?

It is common knowledge that with time, as and when you pay your monthly EMIs (Equated Monthly Installments), you decrease your home loan liability. So if you have a home loan of say 20 lakhs for 20 years, you will owe less to the bank 5 years down the line and even a lesser amount 10 years later. As you approach the 20 years timespan, you pay more and more towards the principal.

How about having a insurance that acts like term insurance but the sum assured is matched to the outstanding liability of your home loan, which is the principal outstanding. That is what a HLPP does.

So if you think for a moment, the sum assured or the life cover in a HLPP decreases with time and at any point of time is equal to the outstanding principal as per the home loan amortization chart.

Check the below for a home loan of Rs 20 lakhs for 15 years at 11% rate of interest. As you can see, the total principal that you pay in each year is increasing and the interest is decreasing and so the outstanding home loan liability is also decreasing.

The life cover or sum assured in a HLPP matches at any point of time to this outstanding loan amount.

Which one is better among home loan insurance or term insurance ?

A term insurance is a no nonsense insurance policy – plain, easy to understand, cheap and the best form of covering liabilities. It is recommended by financial planners world wide.

The issue with HLPPs is the way it is sold in India.

It is in the banks best interest to sell you a home loan protection plan as they need to ensure either you or the insurance company pays their loan back to them. The issue is that they bundle the premium, usually a single one time premium applicable when you take the home loan, with the loan itself.

So, if you have a loan of Rs 20 lakhs and the single premium comes to Rs 25,000/-, the bankers will promptly make your loan amount as Rs 20,25,000/- ! So you end up paying extra EMIs for the Rs 25,000/-.

And when you do this, you lose on the tax benefit because the premium was not paid by you – the tax laws require you to pay the premium to avail of any tax benefit.

 

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