Is your bank-sold home loan insurance a hidden gem or a sneaky upsell?
It's crucial to understand the terms of this insurance, as it can significantly impact your financial obligations and increase your overall income outgo.
- Jun 18, 2024,
- Updated Jun 18, 2024 11:04 AM IST
When you secure a home loan, your bank typically provides a sanction letter. In addition, they may offer a home protection insurance plan designed to safeguard the loan disbursement amount.
It's crucial to understand the terms of this insurance, as it can significantly impact your financial obligations and increase your overall income outgo.
Home loan insurance is a guard against the risk of default on a home loan in the event of the death of the borrower. In such an event, during the loan tenure, the insurance company will settle any outstanding amount on the home loan with the lender. However, home loan insurance products can be more expensive than term loans. Also, if there is a single premium policy bundled with your home loan, you may not be able to port your insurance if you ever switch your lender.
Moreover, the tenor of the policy is usually the same as that of the home loan. However, if the tenor of the loan goes up due to a hike in interest rates, the insurance cover may not be able to cover the loan fully. So, the nominee of the borrower may have to shell out extra if the borrower dies.
Adhil Shetty, CEO of BankBazaar.com, clarifies, "Purchasing home loan protection plans is not a legal requirement. Neither the law nor regulatory bodies like the Reserve Bank of India or the Insurance Regulatory and Development Authority of India mandate the purchase of such plans with a home loan. The decision to buy an insurance plan is entirely up to the borrower. No one can compel you to make this purchase."
"The term policy, on the other hand, might provide the borrower with cost-effective insurance against all liabilities, including home loans. So their family would be better equipped to face all financial eventualities with term insurance," added Shetty.
Here is how you can reduce the Equated Monthly Installments (EMIs):
Opt for a shorter tenor: A shorter tenor means you will be paying higher EMIs but your loan also gets over much faster, which means lower interest outflow. For instance, the total interest on a Rs 40 lakh loan for 20 years at 8.5% is approx. Rs 43.3 lakh compared to approx. Rs 31 lakh for a 15-year loan. That’s a difference of Rs 12.3 lakh. At the same time, the increase in the EMI is less than Rs 5000 per month. The same principle is applicable when you prepay your loan. As you repay your principal faster, the interest accruing on your outstanding begins to reduce.
Opt for a smaller spread: In the case of a repo-linked loan, your loan interest rate is directly pegged to the repo rate. The bank charges a Spread on top of it to compute the lending rate. "The smaller the spread on the repo, the lower will be your interest rate. In many cases, the bank will not change the spread on the loan for the tenor of the loan. This means that when the repo rates change, your spread will be the same. Over the last few years, spreads on loans have fallen significantly, from 3-3.5% in 2020 to as low as 1.9% currently. So if you have a huge spread, you may want to consider refinancing your loan to reduce your spread," said Shetty.
When you secure a home loan, your bank typically provides a sanction letter. In addition, they may offer a home protection insurance plan designed to safeguard the loan disbursement amount.
It's crucial to understand the terms of this insurance, as it can significantly impact your financial obligations and increase your overall income outgo.
Home loan insurance is a guard against the risk of default on a home loan in the event of the death of the borrower. In such an event, during the loan tenure, the insurance company will settle any outstanding amount on the home loan with the lender. However, home loan insurance products can be more expensive than term loans. Also, if there is a single premium policy bundled with your home loan, you may not be able to port your insurance if you ever switch your lender.
Moreover, the tenor of the policy is usually the same as that of the home loan. However, if the tenor of the loan goes up due to a hike in interest rates, the insurance cover may not be able to cover the loan fully. So, the nominee of the borrower may have to shell out extra if the borrower dies.
Adhil Shetty, CEO of BankBazaar.com, clarifies, "Purchasing home loan protection plans is not a legal requirement. Neither the law nor regulatory bodies like the Reserve Bank of India or the Insurance Regulatory and Development Authority of India mandate the purchase of such plans with a home loan. The decision to buy an insurance plan is entirely up to the borrower. No one can compel you to make this purchase."
"The term policy, on the other hand, might provide the borrower with cost-effective insurance against all liabilities, including home loans. So their family would be better equipped to face all financial eventualities with term insurance," added Shetty.
Here is how you can reduce the Equated Monthly Installments (EMIs):
Opt for a shorter tenor: A shorter tenor means you will be paying higher EMIs but your loan also gets over much faster, which means lower interest outflow. For instance, the total interest on a Rs 40 lakh loan for 20 years at 8.5% is approx. Rs 43.3 lakh compared to approx. Rs 31 lakh for a 15-year loan. That’s a difference of Rs 12.3 lakh. At the same time, the increase in the EMI is less than Rs 5000 per month. The same principle is applicable when you prepay your loan. As you repay your principal faster, the interest accruing on your outstanding begins to reduce.
Opt for a smaller spread: In the case of a repo-linked loan, your loan interest rate is directly pegged to the repo rate. The bank charges a Spread on top of it to compute the lending rate. "The smaller the spread on the repo, the lower will be your interest rate. In many cases, the bank will not change the spread on the loan for the tenor of the loan. This means that when the repo rates change, your spread will be the same. Over the last few years, spreads on loans have fallen significantly, from 3-3.5% in 2020 to as low as 1.9% currently. So if you have a huge spread, you may want to consider refinancing your loan to reduce your spread," said Shetty.