If you are in the process of taking out a mortgage loan to buy a home, you will most likely be required to purchase insurance along with it. It’s so much the norm that homebuyers rarely question this practice by banks. Admittedly, having adequate insurance coverage is a very sound risk management practice that is recommended as part of good financial planning. But it’s your right to look at your situation holistically and take control of the process, rather than stick with the product you’re offered.
The first point to note is that, despite what the lending bank would have you believe, insurance is not a statutory precondition for a mortgage loan. You should note that the Reserve Bank of India has not issued any directive on mortgage insurance.
Not only that, even if you want to take out insurance, banks often restrict your options by promoting a particular insurance company instead of offering options. And they may also try to sell features that limit your flexibility while increasing your cost. For example, they can add home insurance, which covers damage to property and belongings due to natural disasters. This covers very different risk scenarios and may not be useful in some cases, for example if the property is under construction.
A popularly marketed product is the “loan protection plan.” This provides insurance on the outstanding amount of the loan and the coverage generally decreases over the years as the loan is paid off. This is also usually a single premium plan with the option to pay the premium with the EMI. Benefits may be advertised as no additional cost to secure the loan. This may seem like a great deal, since the insurance is “perfect” to cover the loan and has no upfront costs.
But there are many hidden disadvantages. For one thing, if you prepay the loan early, you are not covered by the loan tenure. Also, if you refinance the loan with another borrower, the insurance cannot be carried and you have to take out new insurance coverage. Often, you cannot get loan facility against the policy.
There may also be a critical illness or disability coverage package. The problem here is that these are usually not for the full tenure of the loan, but stop after a shorter period of say five years. To save costs, it may be better to buy them for longer periods from the start.
That said, it is important to recognize the need for insurance coverage as a risk mitigation strategy. You need to evaluate your financial situation, including your projected liabilities and expenses, health risks, and valuables that may be vulnerable to arrive at the types, features, and amount of coverage you need. The minimum amount of coverage you need should cover home loan payments in the event of an eventuality to avoid defaults that lead to liquidation.
Simple term life insurance is often all you may need. If you already have one, be sure to check to see if it will still be enough, as your liabilities increase with a new home loan. You can assign an existing policy to the lender against the loan, instead of having to take out a new one.
And if you prefer, you can consider a home policy that covers the building and its belongings against events such as fire or theft. These are very cheap – around ₹200 per lakh sum insured. Other products, such as personal accident and critical illness coverage, may be optional. Be sure to check if your employer’s coverage already includes them and if it’s enough.
You should also buy the best products, as other insurers may offer features that may be beneficial. For example, some loan protection plans come with flexible terms, as little as five years. You should also read the fine print in the policy being offered, as there are many exclusions in the coverage that can limit your benefits.
To take action
If the bank insists that the insurance is mandatory under the regulatory guidelines, you can approach the customer complaints cell of the bank in question. If it is not attended to within a month, it can be escalated to the banking customer’s ombudsman.
Promotion of specific plans
Additional coverage package
Single premium payment
The bank is likely to insist that the insurance be mandatory based on its internal guidelines. You can check if you can assign a policy, which you already have or take now, for the loan. It is preferable to do this, rather than fully combine the insurance with the loan. You have the right to declare that customers should be allowed to exercise their choice and that there can be no links between the loan and other services of the bank.
The author is an independent financial consultant.
March 26, 2022