Why is life insurance a condition on loans?
[social_share]Life insurance can be required as a condition for many types of loans and there are good reasons for this.
The loans that tend to insist on life insurance for the borrower are large loans which don’t have adequate protection from assets secured or available. One example is a mortgage with a very low deposit, or a business loan where the business owner doesn’t have adequate equity in a house to balance the lender’s risk.
Loans, particularly large loans, usually require some kind of security to mitigate the lender’s risk. For example, when buying a house a borrower may be able to lay down a deposit. If the deposit is 20% of the home’s price, the lender will only need to advance 80%, but will have the loan secured against the entire house. If the homeowner defaults, the lender will be able to recover the entire amount loaned, as long as the house price doesn’t fall by 20% or more.
However, this won’t be the case if the deposit is small or the loan is larger than the value of the house, if for example the home buyer needed additional funds for furniture or other costs of setting up home. In this case the lender is effectively lending on the creditworthiness of the borrower. Even if the borrower is creditworthy there will still be an issue if the borrower dies.
The life insurance required usually must be paid for by the borrower and taken out on his or her life, while the beneficiary in the event of death will be the lender. This makes the life insurance a hidden cost on the loan, which can be avoided by taking another loan, perhaps with a higher interest rate but either no requirement for life insurance or a lower one.
Before applying for a loan it’s a good idea to check for any life insurance requirements. A hidden cost of a few thousand dollars extra can be considerable if a life insurance clause is triggered.
It’s often possible to shop around for the life insurance. If there are two loans available, one which allows for shopping around and another that doesn’t, this may be sufficient reason to opt for the first one.
