Have a home loan ? Take term insurance !

“Home loan Term Insurance” are four words that ought to go hand in hand. Practically that is but it seldom happens.

You would take a home loan to realize your long cherished dream of owning a house. For a middle class investor in India, this is a very strong financial goal to achieve and he cannot let it go at any cost. Part of the reason stems from the fact that real estate as an investment avenue is very luring, easy to comprehend, tangible and has historically been a good Return on Investment decision, never mind the fact that equity was even better.

Even our parents and grand parents never had the opportunity and instinct to own a piece of brick as young investors do today.

So the question is when you finally buy that piece of bricks strung together and take a home loan for it, why do investors not protect themselves with a term insurance and let that ownership pass onto a lender ? Let me explain.

The home loan

I am sure we all know how do loans work. When you take a home loan, say from a bank, then the bank lends you money to purchase your dream home. You take the money from the bank, give is to the builder and register the property in your name.

Since the bank was kind enough to lend you money, it expects to earn out of it via interest on the amount lent. Paying both the interest and capital borrowed, also called principal, is done through EMI, Equated Monthly Installments.

So, imagine the situation for a moment. You and your family of three (OK four !), namely your wife who is not working and slogging away in the kitchen and two lovely kids are staying in a house which is registered in your name but technically owned by the bank !

What is the problem with that ? Nothing. As long as you, the primary bread winner of the family can bring home the salary each month to pay the EMI, then there is no problem. The issue starts, when your income stops. And that can happen when you are no longer around – stone dead in short.

Imagine now what your family members have to go through. They might be asked by the bank, the technical owners of your house, to pay up the home loan. Otherwise they threaten to sell off the house to recover the capital you borrowed from them.

And in distressful times as these, while they are coming to terms with your loss, they might even be evicted from the house. So with no money for expenses each month, they now have no place to stay ! The natural reaction is to dip into the savings, if there are any, to take care of such payments. Dipping into savings means using money that was set aside for future important events like education and marriage of children. That is no good either.

“Why so serious ?” ! This happens because of imperfect financial planning. You should have taken something called term insurance to get your family out of the rut after your death.

The term insurance to your rescue

For the uninitiated, term insurance is protection wherein your family receives a large sum of money from an insurance company upon your death. With this money, your family can take care of their daily living expenses and future requirements of lump sum money.

Term insurance is meant to compensate your family with the potential income you would have earned if you were alive. Since you are not around, someone else pays your family money. The only rule of the game is that, when you are alive,  you need to pay the insurance company an amount each year, called premium. The amount the insurer is ready to give out in case of your death is called Sum Assured. This amount is agreed upon when the contract of insurance is pulled together between you and the insurance company. You know it at the start.

So does it not make sense to have an insurance company pay the home loan amount to your family so that they can pass it off to the lender and retain the house for dwelling purposes ? Yes, I know you are nodding your head in agreement.

Let’s take an example.

Suppose you bought a home worth Rs 60 lakhs. You were expected to down-pay 30% which is Rs 18 lakhs and the rest of the money, Rs 42 lakhs came in the form of a home loan from a bank. So on your demise, your family needs Rs 42 lakhs from an insurance company so that the home loan can be paid off and the house retained for them.

What an informed, if not intelligent investor would have done is taken an extra term insurance of Rs 42 lakhs when the home loan was taken from the bank. And here is the stunner. For a 30 year old healthy male, a term insurance for 30 years for an amount of Rs 42 lakhs will come at a meager Rs 6,000 maximum ! That is the amount of money you needed to pay each year to an insurance company for your family to retina the house for you after your death !!

In your life, there will come many occasions when such life style events happen. With each such event, you need to ensure that you revisit risk in your overall portfolio and assess whether you need to take on more insurance to protect your near and dear ones. A new property on loan, birth of a new child, purchase of a new car on loan are examples when you need to increase your term insurance cover to protect your family from feeling the heat from lenders.

Also read whether having a term insurnace or having a home loan insurance for this purpose is better. What are your thoughts, dear readers ?