When raising a personal loan, lenders often urge the borrowers to opt for loan insurance. This is to make sure that any unforeseen circumstance does not prevent the borrower from clearing the loan obligation.
Difficulty in loan repayment could arise due to unemployment, disability or even the borrower’s demise. Although it is optional to take insurance, it is highly recommended to minimise the impact of these untoward events.
Loan insurance: These are the key characteristics
1. Just like any insurance, loan insurance entails an assurance given by the insurer to the lender that the loan will be repaid if the borrower fails to meet his obligation.
2. The insurer charges a premium for this insurance which is not paid separately but is added to the monthly instalment or the loan EMI.
3. Loan insurance, although recommended, is not mandatory. Those who don’t want to take the added burden of insurance premiums can decide to overlook the benefits offered by it.
4. Typically, lenders urge borrowers to opt for it. So, at the time of accepting the loan’s terms and conditions, the borrower is supposed to opt out of the option of loan insurance if s/he does not want it.
5. Some lenders offer loan insurance as a life insurance and the death cover is essentially the outstanding loan balance at the time death as per the amortization schedule. For instance, SBI Life – RiNn Raksha is one such plan. Another insurer offering loan insurance is PNB MetLife which has an offerng by the name of ‘PNB MetLife Complete Loan Protection’.
Impact of loan insurance
1. Loan insurance does not typically affect the interest rate as such factors as creditworthiness, loan tenure, and lender policies determine the rate.
2. Adding the insurance premium to the loan increases the borrowing cost. For instance, financing the premium with the loan means paying interest on the premium over the loan tenure.
For example, if someone takes a loan worth ₹5,00,000, and the insurance premium is ₹5,000, the loan amount becomes ₹5.05 lakh, thus leading to a higher EMI.