One should ideally match a new home loan with a term insurance of equal or higher value. Term insurance is meant to not only protect your assets including life earnings potential, but also your life’s liabilities. In fact, when a bank disburses a home loan, it would also follow up on a term insurance aimed at the liability. Here, we list out the reasons why a term insurance is needed and also why it should be preferred over banker-issued insurance for home loan provided by them.
Liability protection
Just as one would safeguard one’s lifetime’s earning potential against death with a term insurance, a home loan liability should also be ringfenced with term insurance. One might rely on an earlier term insurance for protection, but that would be inadequate. An older term insurance was sought to protect assets and liabilities that would not have included a future home loan. On taking a significant liability, protection measures against failure to meet that liability can be achieved with a new and matching term loan.
Also, policyholders should raise a new term insurance equal to the value of the home loan or higher. Higher covers would ensure that any interest accruals in any eventuality are also met with, but the minimum should be equal to the current value of liability.
In case the liability is wound up by pre-payment in a span of five years or more, policyholders would benefit from persisting with the term insurance. In a span of five years or more, policyholders’ asset base and human life value of earnings would also have increased, which can be protected by the term insurance. There is also a cost advantage of taking a cover at an earlier age, even if the liability has disappeared.
Home loan insurance or term insurance
A home loan insurance plan is also offered by the banker on disbursal of the loan. As the name indicates, it intends to protect the home loan, just as a term insurance does. But there are differences in the plan.
A home loan insurance is geared towards the pending balance of the home loan. As the loan is repaid, the cover amount also decreases and so does the premium amount. This is one clear advantage over term insurance if cost is a priority for the policyholder, and not the coverage.
But in case of an unfortunate event, the loan outstanding to the bank is repaid and the insurance is lapsed. This basically implies a cash flow from the insurance company to the banker, with the policyholder and his family not involved in the process. Essentially, while paying the periodic premiums themselves, the policyholder is insuring their EMI payments and also of the banks which are receiving the EMIs.
But in a term insurance, the family receives the cover amount and has the discretion to clear the loan and will also be left with the balance (assuming the cover is higher than outstanding). This is because, a term plan is fixed benefit policy unlike a decreasing cover policy in home loan insurance.
A home loan insurance is tied to the home loan and the bank issuing the home loan. But a home loan would periodically need to be ported to other banks and is one tool to lower the interest rate on the home loan. Such an exercise would involve lapsing of the home loan insurance and reissuing a new insurance with the new banker, making it a cumbersome process. But for a personal term insurance, choice of the banker is irrelevant.
On the whole, it is prudent to pair your new home loan with a new term insurance. For the cost-conscious, home loan insurance can work, but for others with a focus on coverage and control over the policy, an independent term insurance would be preferable.