When rates rise, a home loan protection plan may not entirely cover a house loan liability. A term plan makes better sense
You always know that the equated monthly installment (EMI) on your housing loan with floating interest rate would go up every time you hear that the Reserve Bank of India (RBI) has raised its policy rate. Last week was no different, when the banking regulator again raised its policy rates — for the 11th time since March 2010 — by half a percent.
Now, it is the turn of the banks and housing finance companies to raise their benchmark rates. This would push your equated monthly installments (EMIs) up. Those who can afford to pay the extra EMI would settle for a higher EMI. Others would have to settle for an increased repayment term for loan. Matter settled? Not really.
Did you figure out what would happen to your home loan protection plan (HLPP)?
For those who came late, HLPP, also known as mortgage reducing term insurance plan, ensures that the insured amount would be made available towards the repayment of your loan on your death or on loss of income due to disability. This makes sure that your family or dependants do not have to worry about the loan's repayment and your home will not be taken away by the bank.
So far so good. However, the trouble begins when the EMI or the tenure of the loan goes up because of the rising interest rates.
Let's look at it with an example. Say Raju has taken a home loan of . 20 lakh for a tenure of 20 years. At an interest rate of 9%, his EMI will work out to . 17,995. Now after six months, the interest rate goes up by say 50 basis points to 9.5%. Raju wants to keep the EMI unchanged, so his outstanding loan tenure will increase to 261 months instead of the original 234 months. And the outstanding loan amount will be . 19.81 lakh.
Two more such rate hikes at an interval of six months each will take the interest rate to 10.5%. Again, to keep the EMI constant, the outstanding tenure has to be increased to 348 months.
Now, if the borrower were to die after paying six instalments at 10.5%, the loan outstanding would be . 19.52 lakh. If Raju had taken an HLPP, his dependants will have to fork out . 31,000 to keep the house. This is because, the HLPP insurance, based on the original loan repayment schedule at 9%, would cover only . 19.21 lakh — the outstanding loan amount as per the original schedule.
In case the extended loan tenure goes beyond your retirement age, the bank asks you to pay a lumpsum amount, since the EMI amount cannot be increased beyond a point.
If the tenure of the loan increases due to an increase in interest rates, you would have to apply again to the insurance company for an additional coverage.
The Solution
Now, when the rates went up, Raju could have bought an additional HLPP to save his dependants the headache of having to close the loan from their own pockets. However, this is easier said than done.
First, it is difficult for an individual to forecast for how long interest rates will rise and by how much. Second, it is not practical to apply for an additional insurance every time the interest rates rise.
Raju had another option to cover his housing loan. He could have bought a term insurance cover of . 20 lakh, which would have helped his dependants repay the entire outstanding loan amount.
In fact, in a rising interest rates scenario, you may choose to buy a term life insurance plan for a term longer than the loan tenure to ensure that the coverage remains even if the loan term is extended by the bank.
Term Advantage
Borrowers often foreclose home loans, especially if they receive surplus money.
Many Indians take a loan for 15-20 years, but prepay it in 8-10 years,.
Once the loan is closed, the HLPP becomes void. An HLPP may be void even if you try to switch from one home loan lender to another. A borrower usually changes lender to get a better deal on home loan rates.
If you switch the loan, then you need to buy an HLPP from the new lender. Of course, this generally happens during a falling interest rate scenario. But, given the longterm nature of a home loan, such a possibility cannot be ruled out even when the rates are high.
Customisation
Lastly, since an HLPP is offered on the group platform, the group administrator decides on the insurance cover and the terms of the cover.
An HLPP may offer life cover and accident disability cover, but may not offer a critical illness cover. A borrower with a family history of critical illness will look for a critical illness cover. The possibility of customisation is minimum on a group insurance platform.
Term life insurance policies are meant to pay the nominee of the life assured.
Hence, even if you move from one borrower to another, you can continue with one plan and that takes care of the problem. You may choose to buy critical illness cover along with a term life insurance product.
The Other Side
However, it may not be easy for everyone to buy a term plan. There are stringent medical tests, which one has to go through before one gets a long-tenure term life insurance.
Lifestyle issues such as tobacco habit, adverse family history, occupation hazards make term plans less accessible. That is where one can consider HLPP, as it is more customer friendly given the ease with which it can be purchased, the relaxed underwriting rules and expert assistance for claim settlement.
As you can, see it is better to buy a term life insurance – preferably for a longer term than your housing loan. If you cannot buy a term insurance for some reasons, HLPP is a good option.
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