Loan Insurance: How It Can Protect Your Borrowed Funds

Loan insurance gives the lender confidence that the loan will be repaid when things go wrong, such as through unemployment, disability, or even the borrower's death. Though it is not mandatory, lenders usually attract borrowers to purchase loan insurance to minimise potential financial risks arising from the unexpected situation.

What is Loan Insurance?

Loan insurance is an agreement between the insurer and the lender where the insurer guarantees repayment if the borrower cannot meet their obligations. This assurance covers situations like job loss, severe disability, or death.

Loan insurance is also recommended, but it's not required. Loan insurance protects both the borrower and their family from any financial hardship caused by failing to repay loans. It is the obligation of borrowers to opt-out if they do not want to take loan insurance, which comes with terms and conditions during acceptance.

Important Features of Loan Insurance

Assurance to lenders: Just like other types of insurance, loan insurance ensures that in the event of a default where the borrower cannot pay the lender, the outstanding amount on the loan will be paid.

Inclusion of premium: Normally, the premium is added to the EMI rather than having to pay the premium separately. This is usually an added advantage for borrowers because it helps them in settling the premium.

An option covering insurance may not be at all mandated and therefore allows for wider choices for the borrowers as they would not have wanted to bear the additional weight of the premiums.

There are also different types of life cover choices that the loan insurances come with. For instance, SBI Life's 'RiNn Raksha' or PNB MetLife's 'Complete Loan Protection' covers the residual value in case of death, which may be met as compensation to the bank.

Impact on the EMI and Borrowing Cost

Loan insurance directly influences borrowing costs but has no say in the rates of interest, which remain at the mercy of one's creditworthiness, loan tenor, and lending bank policies. That means there are added interest payouts toward an increased amount under the loan during its entire tenure.

For example, if a borrower takes a loan of Rs 5,00,000 and the insurance premium is Rs 5,000, then the loan amount becomes Rs 5.05 lakh. This adds to the EMI burden over the loan period.

Loan insurance is a financial safety net that ensures loan repayment in case of unforeseen events. Though it adds to the cost of borrowing, the benefits of protection from financial distress make it a worthwhile consideration for many borrowers.