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Nath Balakrishnan

OWNING a house probably tops the order of priorities for most. Though it calls for a substantial investment, the availability of loans at competitive rates has made house shopping easier. These days it is not uncommon to find people in their mid-thirties deciding to invest in a house to take advantage of the financing options available.

With the joy of owning a house comes the responsibility of ensuring that the amount outstanding under the loan is paid at regular intervals. But what happens if the person who has taken the loan meets dies during the loan repayment period?

If subsequent repayments cannot be made, the agency that gave the loan can repossess the property. In such circumstances, a loan cover term plan is handy as it provides a lumpsum amount on the insuree's death. This can be used to repay the outstanding amount of the loan.

How it works

The sum assured that one chooses under this policy need not be the same as the loan amount taken — it can be higher or lower.

The amount payable on the policyholder's death will decrease every year to account for the loan repayments being made by the policyholder.

This decrease will essentially reflect the principal amount outstanding under the loan. When repaying a housing loan, a large proportion of the initial payments made will be towards the interest.

As one approaches the term end, the bulk of the repayments is for the principal. To go with this pattern in loan repayment, the diminution in lumpsum amount payable will be lesser in the initial years and greater as one approaches the term end.

For instance, let us assume that the policyholder has taken a Rs 5 lakh sum assured policy over a 10-year term.

At the end of the first year, the lumpsum amount could be Rs 4,75,000 (to reflect the large outstanding principal on the loan). The reduction in the lumpsum amount will gradually accelerate as one approaches the eighth, ninth and tenth year of the policy term. This implies that the reduction in the lumpsum amount is not the same every year.

Should the policyholder die in the eighth year of the policy, the decreased sum assured corresponding to the year of death will be paid. This amount can be used to settle the amount outstanding under the loan.

Policy features

HDFC Standard Life and MetLife offer such plans. Unlike an endowment or a money-back policy that incorporates a savings element and provides a lumpsum on maturity, these plans have no survival benefits attached to them.

If the policyholder survives the plan term, he will have to forego all the premium paid — making this plan similar to a pure term plan.

The plan is available in both the single and the regular premium paying options. Another feature the regular premium paying option is that one needs to pay premiums only over two-thirds of the plan term.

For example, for a 15-year plan, premiums need to be paid only till the 10th year. The insurance cover, however, extends over the entire term duration.

The premiums that one needs to pay remain fixed over the premium paying tenure. This is despite the trend of a decline in the lumpsum payable as one progresses through the policy term.

`Loan vs Pure' term plans

As they are similarly structured, a comparison between the two plans is only natural. As with term plans, a policy's competitiveness is determined by the premium for a given sum assured.

As the table shows, the sum total of premiums required to be paid in the case of HDFC's loan cover plan is greater that what one will pay for a pure term plan of ICICI Prudential.

There are two distinct advantages that a pure term plan provides. For one, the sum assured under it is constant throughout the policy tenure, and there is no decrease as in the case of the loan cover term plan. This means the beneficiary will stand to receive a higher amount on the policyholder's death. Secondly, term plans also allow riders to be attached to them. The same is not available in case of loan cover term plans.

How to choose

As a rule, a lower age at entry would mean a lower premium outgo in the case of both the pure term and loan cover term plans.

As the table shows, for a 30-year-old taking a plan for Rs 10 lakh sum assured over a 10-year term, the pure term plan still scores, as it entails a lower premium payout. Those taking a housing loan in the late-twenties will be better off buying a pure term plan.

However, with advancing age, the cumulative premium payouts are lower in case of the loan cover plan (see accompanying table for figures). For those in the mid-forties, an evaluation of the benefits of both the plans will be in order before determining the suitable plan. The loan cover term plan will also be suitable in the case of lower amounts, for which pure term plans may not be available on account of not meeting the minimum premium payment criterion.

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