Mortgage insurance

A home loan gets smaller every month as EMIs are paid. Mortgage insurance is built on that same idea: the sum insured is designed to reduce over time, roughly tracking the loan balance that is left.

The logic is simple. If the borrower dies, the family should not be left owing the bank money on a house they cannot easily sell. Mortgage insurance exists to close exactly that gap, no more and no less, rather than paying out a large, fixed sum regardless of how much of the loan has already been repaid.

In theory, a reducing-balance mortgage insurance policy should cost noticeably less than a level term insurance plan of the same starting sum assured, because the insurer's liability shrinks every year as the loan is repaid. On a 20-year loan, the cover in year 15 might be a fraction of what it was on day one, so the theoretical case is a materially lower premium.

In practice, the workbook says this saving rarely shows up. Reducing balance mortgage insurance is often not much cheaper than a level term plan, and, in an ironic twist the workbook flags directly, the mortgage insurance premium can in some cases work out more expensive than a level term plan bought separately for the same starting cover.

The reason is structural: a mortgage insurance policy is usually sold bundled with the loan, priced by the lender's tied insurer, with less competitive pressure than the open term-insurance market. A borrower who simply buys a standalone term plan for the loan amount, letting the cover stay level while the loan itself reduces, often ends up with more protection for a similar or lower premium.

Mr Shetty takes a home loan of Rs 50,00,000 over 20 years. His bank offers mortgage insurance with a premium of Rs 42,000 for the full term, with cover reducing in line with the loan balance.

A standalone level term plan of Rs 50,00,000 for 20 years, from a separate insurer, costs him Rs 38,000 for the same term, cheaper, despite the cover staying level and therefore, on paper, more generous in later years when the loan balance is much lower.

Because the term plan does not automatically end when the loan is repaid, Mr Shetty holds cover in year 18, when the loan balance may be only Rs 8,00,000, worth the full Rs 50,00,000, protection well beyond the mortgage, at a lower price than the product built specifically to track it.

Chapter 2 (Features of Life Insurance Products) introduces mortgage insurance immediately after reducing term assurance, noting the theoretical cost saving and then correcting it with the practical observation that the saving rarely appears and the policy can even cost more. Expect a conceptual question testing whether candidates know the theoretical case for mortgage insurance versus what the workbook says happens in practice.

• Theory says cheaper; the workbook says practice often is not. An exam answer that assumes mortgage insurance is always the lower-cost option is testing exactly this gap.
• Reducing cover is not the same as a guaranteed lower premium. The sum assured falls, but the pricing does not automatically fall in step.
• A level term plan can outperform mortgage insurance on both cost and coverage, because it does not taper down and can be shopped for competitively.
• Mortgage insurance is tied to the loan, so it typically cannot be transferred if the borrower refinances with a different lender. A standalone term plan is portable.