Loan against insurance may be good, but gauge the risks first

MUMBAI: The news that Life Insurance Corporation (LIC) of India has recently surpassed banks as the largest personal loan lender has turned the focus on insurance policies as collateral. Apart from LIC, other life insurers like ICICI Prudential Life and Edelweiss Tokio Life, and several banks, including the State Bank of India (SBI), ICICI Bank and HDFC Bank, offer loans against pledging of life insurance policies.

The Procedure Loans are granted only against traditional policies like endowment and money back policies that have life cover along with savings element in them. Term insurance covers and unit-linked insurance plans cannot be pledged to secure loans against them.

Policies must acquire surrender value -the amount you would get if you terminate the policy after a certain years -to qualify for loans. You must assign the policy in favour of the insurer to get a loan. Typically, insurance companies offer loans up to 85-90% of the surrender value. LIC charges an interest rate of 10%, to be paid every six months.

The repayment schedules are flexible, with LIC giving you the option of paying only the interest amount and allowing the loan amount to be deducted from the claim amount at the time of settlement. If you are seeking a loan from a bank by pledging your policy , the interest rate and repayment procedure will vary as per the bank. The Benefits Clearly, loan against an insurance policy can offer succour to policyholders during emergencies with minimum documentation. The interest rate is a shade lower than what banks charge for their secured loans and significantly cheaper than personal loans (see table).

The flexible repayment schedule -and the option to allow the loan amount to be deducted from the claim amount -is a good enough reason for it to be your top choice during a crisis. Then, there are other benefits. For one, you need not worry about the application being rejected or delayed.

“There is no question of verifying the credit risk of the person and setting the interest rate for himher. For people with low credit scores, this is a very good option. Also, these days, LIC is giving the loan in seven days,“ says Suresh Sadagopan, founder, Ladder7 Financial Advisories.The Flipside If the policyholder dies while repaying the loan, hisher dependents will not be the sole beneficiaries of the insurance policy.

The lender will have the right to deduct the loan amount plus interest from the proceeds. If you don't have plans to repay the loan immediately, it will be a great idea to shop for term cover to safeguard the interests of your family. Online term plans are cheaper -a one crore cover costs just Rs 6,00010,000 a year, depending on your age, policy tenure and life insurance company.

Also, it is best to secure a loan from your insurer rather approaching banks to pledge your policy. For one, there is no risk of your loan request being turned down. In addition, repayment period is flexible and the interest rate is lower -Life Insurance Corporation charges 10%, compared to 12-14% that banks charge for providing overdraft facilities lending against a life insurance policy (or any other security).

“If you intend to use the entire amount sanctioned, you should approach your insurer. If you need money on and off, and are looking at this loan only as a tool to improve your liquidity, you can consider borrowing from banks which offer overdraft facilities against life policies. This will help you use the sanctioned loan only to the extent required,“ says Harshvardhan Roongta, certified financial planner and CEO, Roongta Securities. Since you would be paying interest only on the amount overdrawn, your interest outgo will be capped.