Life Insurance as a Tool for Redemption of Mortgage

2024-08-02

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Purchasing a home is likely to be a top priority in the lives of most working individuals. While the best-case scenario would be to buy property using your own funds, this may not always be possible..

Most people often end up opting for mortgage loans, which allow them to borrow up to 80% of the required amount, with the property itself being used as collateral, and repay it over a fixed period with interest.

These types of loans are typically granted to those with a steady source of income and good credit history. Additionally, the regular payments made, referred to as the Equated Monthly Instalments (EMI), should preferably not exceed 50% of the borrower’s income, as higher EMIs increase the lender’s risk..

Key Takeaways

A life insurance policy can protect your family from mortgage debt if you're unable to repay due to death or illness.
Conventional term plans offer high coverage at low premiums, ideal for covering both life and home loan liabilities.
Decreasing term plans reduce the sum assured over time, aligning with your home loan repayment schedule.
Mortgage redemption plans are designed specifically to cover home loans, but may lack maturity benefits.
Endowment plans offer added features like bonuses or loans, but aren't cost-effective for loan protection alone.

What Happens to Your Home Loan If Something Happens to You?

When considering the fact that these loan amounts are often considerably larger than some other types of loans, such as personal, educational or automobile loans, they can become a huge liability in some situations. These include circumstances where the primary breadwinner in a household either passes away or is incapacitated due to illness or injury. In such cases, the household's income stream is likely to dry up either partially or completely, and their next of kin may find it difficult to make regular payments without defaulting. This can lead to:

Loan defaults, which negatively impact credit history
Accumulated interest increases the financial burden
Loss of collateral, which in most cases is the home itself
Emotional and legal stress on surviving family members

To prevent these outcomes, many individuals opt to link a life insurance policy to their home loan. Having a life insurance policy with such conditions is a recommended step in devising a financial strategy for repaying a mortgage loan.

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Types of Life Insurance Plans That Can Cover Your Home Loan

There are a number of policy types that can be tailored to your home loan needs. The right choice will depend on factors like the loan amount, repayment period, type of coverage you prefer, and your income level. They have various pros and cons, which are vital to understand before deciding upon the best life insurance policy for the redemption of your mortgage:

Conventional Term Plans: Term plans that include loan repayment as part of the death benefit sum are commonly employed to safeguard the policyholder's family from incurring debts, as they offer additional coverage beyond the loan amount itself. A high sum assured is provided with relatively lower premiums as compared to a traditional life insurance policy. Term periods are fixed in these types of policies, and this method is best suited for situations where the loan tenure ends before that of the term life insurance policy itself. This is to avoid the risk of having a lapsed policy at the time of the borrower’s demise.

Top-ups in the form of a critical illness plan provide additional coverage in the event that the policyholder becomes medically incapacitated and is unable to make regular payments. Some plans may even offer investment options or return the premiums paid on maturity, subject to terms and conditions.

Decreasing Term Plans: Decreasing term plans are, in a way, structured to cater to those looking to safeguard their family members from taking on their debts in the event of their passing. In this type of plan, the sum assured is settled upon at the start of the tenure based on the loan amount to be repaid. This sum reduces over time as the loan is paid back and eventually reaches zero on maturity. The premiums in this type of plan are often lower than those of conventional term plans due to the periodic reduction of coverage as debts are repaid.

In some ways, these plans may be the best life insurance policy for those exclusively seeking to deal with existing debt.

Mortgage Protection/Redemption Term Plans: Mortgage protection or redemption plans are specifically catered to securing home loans. This type of life insurance policy is fairly similar to decreasing or conventional term plans, depending on the service provider. One main point of difference is that a portion of the premiums is generally paid up front as a lump sum and may be higher than those of term plans. This amount paid is often not refunded at the time of maturity, as it is a pure protection policy in most cases, with no maturity benefits.

These plans are often bundled directly with the home loan at the time of sanction and may offer the convenience of a one-time payment. However, they typically do not offer flexibility in coverage duration or portability if you switch lenders. For this reason, many borrowers still prefer standalone term plans with higher customisation options.

Conventional Life Insurance Policies: Long-term loans may be secured with the help of a traditional life insurance policy, which accounts for such liabilities in the event of the policyholder’s demise. These policies may offer maturity benefits and investment components, making them suitable for individuals looking for dual benefits of protection and savings.

However, premiums are often higher than those of term plans offering similar coverage. They also require longer commitment periods and may not be ideal if the sole intent is to protect a mortgage.

Additionally, some endowment or whole-life policies may allow for partial withdrawals, loan facilities, or bonuses, subject to terms and conditions. Opting for the iSelect Smart360 Term Plan from Canara HSBC Life Insurance provides flexibility in coverage amounts as well as whole life cover, premium return and short tenures of up to 5 years to ensure that your family isn’t burdened with mortgage repayment in any situation. These features make them more comprehensive but less cost-effective for purely loan protection purposes.

Conclusion

Most of these policies are tax-exempt under Section 80C; however, those with lapsed term policies do not qualify for this benefit. Understanding the amount of coverage you require, as well as any additional top-ups, is vital in picking an appropriate policy type to secure your mortgage. There is quite a bit of information that needs to be digested before you can decide on the best life insurance policy to secure your family against defaulting on your mortgage under any circumstances.

Disclaimer - This article is issued in the general public interest and meant for general information purposes only. The views expressed in this blog are solely those of the writer and do not necessarily reflect the official policy or position of Canara HSBC Life Insurance Company Limited or any affiliated entity. We make no representations or warranties of any kind, express or implied, about the completeness, accuracy, reliability, suitability, or availability with respect to the blog or the information, products, services, or related graphics contained in the blog for any purpose. Any reliance you place on such information is therefore strictly at your own risk. You should consult with a qualified professional regarding your specific circumstances before taking any action based on the content provided herein.

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