Loan Insurance: Know its Meaning, Types, and Benefits

The financial landscape has changed drastically since the pandemic. Many individuals across India lost high-paying jobs during this period, and even successful entrepreneurs suffered significant losses. This unforeseen scenario further contributed to increasing loan defaults and missed EMIs. It was under these conditions that people truly realised the value of personal loan insurance. A loan insurance policy helps borrowers to keep their credit scores intact by ensuring timely repayments regardless of their financial situation. According to the Reserve Bank of India (RBI) Master Direction on Loans and Advances, while lenders may recommend such protection as a prudent risk management tool, it is not mandatory for borrowers to purchase it as a condition for loan approval. Continue reading if you want to learn more about how a loan insurance plan works in India.

What is loan insurance?

Loan insurance is a type of financial product that assists with loan repayment in the event of an unforeseen occurrence such as job loss, partial or permanent disability, or sudden death. In such cases, personal loan insurance helps you in avoiding loan default and protects your family from the burden of debt. The concept of insurance of loan is identical to that of life insurance in terms of risk coverage. The latter protects your family by paying a lump sum in the event of death or disability, whereas the former pays monthly EMIs on your behalf in similar circumstances, up to a certain period typically 3 to 6 months for job loss as per standard policy terms.

This type of insurance is available in the market for various loan products. You can purchase it to cover personal loans, home loans, new car loans, credit card bills, and mortgage loans, among other things. The premium for your loan insurance plan is determined by the coverage you select, the loan amount, your occupation, age, and medical condition. As a regulated NBFC, Hero FinCorp offers transparent loan products and encourages borrowers to evaluate insurance as an optional safety net.

How Does Loan Insurance Work?

Understanding how loan insurance works is simple: When you opt for a policy, the insurer steps in to clear the outstanding debt or pay EMIs if a covered event occurs. For instance, if a borrower faces a critical illness, the insurance provider settles the dues directly with the lender, preventing the account from turning into a Non-Performing Asset (NPA) under RBI's Prudential Norms.

Different Types of Loan Insurance

You will find two primary types of personal loan insurance in India, as described below:

1. Reducing Cover Insurance: In this type of policy, the premium amount is linked to the outstanding loan amount. As time passes and you pay your EMIs, the total outstanding debt balance decreases, as does the policy coverage. When compared to level insurance, reducing cover is generally more cost-effective initially as it aligns better with the decreasing liability of a term loan.
2. Level Insurance: Under a level insurance plan, the sum insured does not change as the outstanding balance decreases. The coverage and premium remain constant throughout the policy's term, providing a fixed cushion that may exceed the actual loan balance over time.

What Factors Influence The Premium Of Your Loan Insurance?

Premiums for loan insurance, like any other insurance, are determined by multiple factors. Simply put, anything that increases the likelihood of a claim filing and adds to the insurer's liability affects the policy cost. These factors are:

• Loan Amount: From the insurer's perspective, the higher the loan amount, the greater the risk of default. Managing large EMIs, especially when opting for an instant personal loan, is not always possible during financial turmoil. Hence, insurers charge high premiums to mitigate their risk.
• Repayment Tenure: Choosing a longer repayment term will undoubtedly lower your EMI, but there is a drawback when it comes to loan insurance. As health risks increase over time, insurers raise premiums to cover their liability for potential claims.
• Age: Statistical data shows that people tend to lose their earning potential as they get older. At Hero FinCorp, we observe that borrowers reaching retirement age may face higher premiums due to increased health risks.
• Health Condition: Your repayment potential is directly related to your health. If a person has pre-existing diseases, including chronic or life-threatening ones, the chances of losing their earning potential are high. As a result, the premium for a healthy person will be much lower.

Things to Consider Before Purchasing Insurance for a Personal Loan

Buying insurance for a loan while ignoring various critical parameters is not advisable. You must evaluate the following to make an informed decision:

• Total Insurance Cost: When purchasing loan insurance, consider the total cost rather than just the monthly premium. If the premium is added to the principal, it may accrue interest (often at the same rate as the loan, which starts at 19% p.a. for many NBFCs, increasing your overall debt.
• Policy Wordings & Exclusions: Pay close attention to the policy wordings and exclusions. If you are suffering from an illness that is not covered, purchasing insurance on a loan amount with that insurer is a complete waste of money.
• Claim Settlement Ratio (CSR): Check if the insurer allows you to file a claim online. Review the latest IRDAI (Insurance Regulatory and Development Authority of India) Annual Report for the insurer's Claim Settlement Ratio (CSR). As leading private insurers maintain a CSR above 95%.
• Payment Method & KFS: Some insurers require you to pay the entire premium upfront, while others charge you monthly. Under RBI’s Digital Lending Guidelines, lenders must provide a Key Facts Statement (KFS) that clearly outlines any insurance premiums bundled with the loan to ensure no hidden costs exist.

Loan Insurance Benefits in India

Having a personal loan insurance cover can offer several advantages. Some of the most notable loan insurance benefits India are:

• Financial Security: In case of an unfortunate event, such as job loss or disability, the policy will pay the remaining EMIs, depending on the policy coverage.
• Credit Score Protection: Timely payouts by the insurer ensure that your CIBIL score remains unaffected by unforeseen financial crises. Under new CIBIL rules, scores are refreshed every 15 days, making timely insurance payouts even more critical.
• Tax Benefits: You may find various loan protection policies in the market that offer tax benefits under Section 80C (for life-linked covers up to ₹1.5 lakh) or Section 80D (for health-linked covers up to ₹25,000/₹50,000) of the Income Tax Act, applicable under the Old Tax Regime as per Finance Act.
• Family Safeguard: In the event of the policyholder's sudden demise, the loan protection policy relieves family members of the burden of debt.

Conclusion

In an era of financial unpredictability, loan insurance serves as a vital safety net that safeguards your family’s future and preserves your hard-earned credit standing. While it is not a mandatory requirement under RBI regulations, the peace of mind it offers during events like job loss or medical emergencies is invaluable. By carefully reviewing the Key Facts Statement (KFS) and selecting a loan insurance plan that aligns with your repayment tenure, you can ensure that your debt never becomes a burden for your loved ones. As a regulated NBFC, Hero FinCorp remains committed to transparency, helping you navigate your borrowing journey with both confidence and clarity.

Frequently Asked Questions (FAQs)

Is It Mandatory To Take Insurance With A Personal Loan In India?

No. According to RBI’s Fair Practices Code, insurance is entirely optional. Lenders may recommend it as a risk-mitigation tool to protect your family and credit score, but they cannot legally compel you to purchase it as a condition for loan approval.

Does Loan Insurance Cover Job Loss? Selectively.

Many loan insurance plans offer a "Loss of Job" (LOJ) rider. This typically covers your EMIs for a limited period usually 3 to 6 months provided the job loss is due to retrenchment or layoffs and not voluntary resignation or misconduct. Always check the Key Facts Statement (KFS) for specific LOJ clauses.

Can I Claim Tax Benefits On My Personal Loan Insurance Premium?

Yes, under specific conditions. If the policy is life-linked (covering death), you can claim deductions under Section 80C. If it includes critical illness or health-related riders, it may qualify under Section 80D. However, these benefits are only available under the Old Tax Regime as of the Finance Act..

How Does Loan Insurance Protect My Cibil Score?

If a covered event occurs (like a critical illness), the insurer pays the EMIs directly to the lender. This prevents "Late Payment" or "Default" tags on your credit report. Since CIBIL now updates scores every 15 days, this immediate payout is vital for maintaining an unblemished credit history.

What Happens To The Insurance If I Prepay Or Foreclosure My Loan?

If you close your loan early, you may be eligible for a pro-rata refund of the premium for the remaining tenure, provided it was a "Single Premium" policy. Per RBI guidelines, the procedure for premium refunds must be clearly outlined in your loan agreement.

Can The Insurance Premium Be Added To My Loan Amount?

Yes. Most lenders, including regulated NBFCs, allow you to bundle the premium into the total loan principal. While this reduces upfront costs, remember that you will pay interest on this bundled premium over the loan tenure, which increases the Annual Percentage Rate (APR).

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