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Last Updated : Nov 16, 2015 12:20 PM IST | Source:

Should you review your insurance after home purchase?

Borrowing for your home changes the asset liability mix of an individual. Home loan also changes the insurance needs of the borrower.

Dilshad Billimoria

Financial plans and the suggested course of action are based on the facts pertaining to you. When a financial advisor hands over a financial plan to you and suggests buying an insurance cover, the value of that insurance cover is based on factors such as your current income, expenses, goals, assets, liabilities and commitments.

But circumstances change over time. New loans, increased salary, higher children education costs, higher expenses, are all variable in nature and therefore, evaluating one's insurance- is important.

Let us understand this with an example. When Manish was 18 years old, his parents had purchased an insurance plan for him for Rs 10,00,000, more as a tax saving mechanism. He probably was not even aware of it or the reason for this cover.

Now Manish is 30 years old, getting married, and planning to purchase a new home for self and his wife. His wife is a home maker. It is prudent to buy an insurance that at least covers the home mortgage amount.

Since Manish has just started his career, the accumulated savings for down payment may not be more than 15% of the value of the property, and hence he would need to take a loan for the remaining 85%. Assuming the cost of the house is Rs 80,00,000, the loan amount taken would be Rs 68,00,000(@85% of value of house)

Since Manish is the sole income earner for now, he should take a pure term insurance cover plan for the remaining Rs 58,00,000, after considering the existing insurance cover of Rs 10,00,000.

This is done to ensure that in case of an unfortunate eventuality of his death, his wife is not left with a home loan burden and no income to pay that loan. She would not be faced with the financial trauma of selling the home to repay loan to the bank. The proceeds from the insurance cover would be used to repay the mortgage to the bank and she would continue to stay in the home.

Again, in his absence how would she continue to maintain the same lifestyle and manage the household expenses? She is a home maker and has no source of income to fund the living expenses.

Therefore, while Manish is re- evaluating the life cover needed at the time of purchasing the new home to cover his mortgage value, he should also consider protecting his family to maintain the same standard of living, should something happen to him to ensure cash flow of the household is not affected.

He must therefore, consider a pure term insurance plan that would pay a lump sum to his wife, should anything happen to him, so that she can deposit the amount in the bank and fund the living expenses year on year till her life.

For that, the present value of income that is used for the family discounted by inflation for the remaining tenure will determine the life insurance needed by the life assured.

Let us say Manish’s gross total income is Rs 5,00,000 per annum. His personal expenses are Rs 1,00,000. His personal income tax payable is Rs 23690. Premium paid by him for his personal life insurance policy is Rs 20,000. Amount available for his family is Rs 3,56,310. Lets round this to Rs 3,57,000 per annum. This is the amount his family would need year on year in his absence to maintain the same lifestyle until retirement.

The human life value for Manish is calculating the present value of all future incomes that he would contribute to his family for the next 30 years (60-30), which is Rs 40,19,028 assuming a discount or inflation rate of 8% per annum. This amount does not include the assumed increase in income that Manish would get through his career.

Therefore, if Manish dies at age 31 years, his family will receive the above amount that will sustain their lifestyle needs in his absence for their remaining life.

If Mr and Mrs Manish are planning to have children, the insurance cover would increase with added dependents and responsibilities of education costs.

Another important cover one must buy is personal accident insurance cover to protect oneself from accidental dismemberment. This means loss of limbs or a part of your body that would not allow you to carry on work with the same level of income. With reduced income, how would one service the mortgage payments? Therefore, there are policies that pay a part of the mortgage to the bank, in case of partial/ total dismemberment.

Homeowners need to purchase home insurance to protect their homes and personal property. Those who rent, need insurance to protect their furniture and other personal property. Everyone needs protection against liability for accidents that injure other people or damage their property.

The higher the coverage, the better, so that you are insulated or insured when a disaster strikes.

Factors to consider for home insurance are -

Compare Deductibles- Deductible is the amount paid by you, should any claim be made on the property. Therefore, you must make sure you are comfortable paying the deductible. Higher the deductible, lower would be the premium, since you are willing to pay more out of pocket expenses at the time of claim.

Replacement cost or Actual Value- The replacement cost is the cost that you would incur to replace an item without depreciation with materials of similar quality. Actual value is the value that you would receive on a claim made, post depreciation. Therefore, you need to re-evaluate the replacement value year on year.

Change in Coverage available- With so many changing terms and conditions and coverage rules, it is important to evaluate what is the best package available presently to protect your home against damage. For example, fire, theft, storm, reimbursement against additional living expenses, doctor visits in case of personal damage, are coverage items to reconsider.

Change in structure- If there are modifications made to the house structure, like addition of new rooms, remodelling, the added costs of replacement should be incorporated in the new policy.

So think twice, before tucking away that insurance bond document in the drawer the next time.

Dilshad is a member of The Financial Planners’ Guild , India (FPGI). FPGI is an association of Practicing Certified Financial Planners to create awareness about Financial Planning among the public, promote professional excellence and ensure high quality practice standards.

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First Published on Nov 16, 2015 12:20 pm
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