Life insurance is the first pillar of financial planning. You must consider buying adequate life cover even before you start planning your investments. And the reason is simple.
If you make a mistake with your investments, you can possibly rectify your mistakes over time.
However, if you make a mistake with your life insurance, you may not get a second chance. What if you pass away without adequate savings and with heavy liabilities? Your family will struggle badly for a long time. Your most basic financial goals such as kids’ education may suffer.
Even when you take a home loan to buy a house, the banks push you to buy insurance products. In case the borrower passes away, the home loan can simply be closed with the life insurance payout and the house remains with the family. Hence, I do not question of utility of covering your home loan through a life insurance product.
Let’s understand with the help of an example.
You buy your dream house using a home loan of Rs 50 lacs. Your family loves the house. You and your spouse have already dreamed about growing old together in the house. You are the primary breadwinner. Most of your savings went into downpayment for the house. Bad luck can strike anytime. If you are not around, how will the family repay the loan? If the loan is not repaid, the bank will take away the house. The demise of a loved one does not only shatter the family emotionally but can also wreck the family finances badly. That’s why buying adequate life insurance is so important.
Purchase of a life insurance product to cover your home loan helps both parties.
- It helps you: In case you are not around, the life insurance payout can be used to close the loan. Hence, your family can continue to stay in the house even after you are not around.
- It helps the bank: If the borrower (primary earner) passes away, it can become difficult to pay off the home loan. In such an event, the bank can take away the house and auction it to recover the proceeds. The problem is that it is a lengthy process and takes time. With a life insurance policy assigned to the lender, it becomes easy to recover money.
Hence, the bank is not exactly wrong in asking you to buy a life insurance plan with your home loan. The problem is in what they sell and how they sell.
#1 Loan Approvals Cannot Be Linked to Purchasing Bundled Products like Insurance
That’s what RBI says. You want to buy life insurance to cover your loan. Please go ahead and do it. The bank pitches you an insurance product while approving your home loan and you like the product and buy it. That’s fine too. However, making loan approval contingent upon purchase of insurance plan is not permitted. Just not allowed.
Given how things work, this is usually the impression borrowers are given. If you don’t purchase the plan, your loan won’t be sanctioned. Again, not allowed. Ask the bank official to give this in writing or an email and they will start back-tracking. You can also send an email to bank customer care to complain about the employee. The bank would never give this in writing.
#2 There May Not Be Informed Consent
Sometimes, the borrowers are not even aware that they are being sold a life insurance plan. Hence, there is no informed consent. You must put hundreds of signatures in any case. One of those signatures may be for purchase of a home loan insurance plan. Since the premium is funded through a loan and you do not have to pay anything extra upfront, you may not even notice it.
You find out about the plan only when you notice a small side loan along with your home loan. And that you have an EMI for that loan too.
Coercing you to buy a life insurance product by linking it to loan approval and selling a plan without informed consent of the borrower are both instances of mis-selling.
#3 These Plans Are Expensive
In the first two points, we discussed problems with “how these plans are sold”. Let’s now discuss these products on merit.
There is a reason why bank people push such products. These products are sold in a tie-up with an insurance company and the bank earns a handsome commission in the sale of product. The banks love fee income. No risk and no tension income. This fee income goes straight to the topline. The bank staff are given steep targets for the fee income. No wonder there is rampant mis-selling.
Life insurance is life insurance.
You could have bought a life insurance plan on your own too and assigned the policy to the bank. That would have served exactly the same purpose. Buying on own would have been much cheaper too. You would have saved a lot of money.
In fact, you can ask the bank to sell you a simple term life insurance from a group company and assign to the bank. SBI Life in case of SBI. Or ICICI Prudential in case of ICICI Bank. HDFC Life with HDFC Bank. You will still save a lot of money (even with their commissions).
These home loan insurance plans (also called home loan protection plans or HLPPs) are just too expensive.
#4 These Plans Can Be Confusing
These home loan insurance plans (HLPPs) come in 2 variants.
- Level cover plan, where the coverage remains constant through the policy term.
- Reducing cover plan, where the life coverage goes down as the loan gets repaid.
Clearly, the reducing cover plan is cheaper because it provides less coverage. Fair enough. The problem is that most borrowers won’t be explained what is being sold to them and this can present unique challenges in certain corner cases as I discussed in this post.
#5 Sometimes, the Plans Are Just a Rip-off
What is the biggest risk to loan repayment? That the policyholder passes away. Yes, there are other risks too. Loss of job, temporary or permanent disability. Yet, the demise of the borrower is the biggest risk.
What if the home loan protection plan does not cover the demise of the policyholder (borrower) due to a natural cause? Would such a plan even qualify to a home loan insurance plan?
Would you be surprised that a prominent private sector bank was bundling an insurance product that covers borrowers for loss of job and accidental death and disability but not for demise due to a natural cause? Isn’t this mis-selling? It is. Everyone in the value chain except the borrower knows this. The family members of the borrower would also know this only when he/she passes away.
Considering #4 and #5 together, the banks know the limitations of such plans. That how these plans won’t even serve the intended purpose. Still, they sell these plans. It is difficult to believe that the senior management in the banks is not aware of these shenanigans. You can’t hold such unscrupulous people in high regard.
What Should You Do Instead?
Well, the banks will do what they do. You can’t stop them. Perhaps, the respective regulators, especially the IRDA, are not too keen to stop this mis-selling. However, you must not drop your guard.
Here is what you must do:
- Always have adequate life insurance coverage.
- Nothing wrong in buying term life insurance to cover your home loan. You can buy a fresh plan or can assign your existing life insurance to the bank.
- Do not let the banks bully you into buying a bundled plan. Stand your ground. If they give you the impression that your loan won’t get approved unless you buy, ask in writing. Report the malpractice over an email to the bank customer care or grievance email ids.
- Be aware. Even if you must buy a bundled insurance product from the bank (not a good idea but better than no life cover at all), ensure that it is a term life insurance product (and not home loan protection plan) and covers demise due to any reason. It is your responsibility to ensure that your family does not suffer when you are not around.