Insurance sold with the mortgage: what 6% upfront is worth in rate terms

Somewhere late in the approval process, usually after the credit decision and before signing, an insurance product appears. Credit life cover, borrower protection, a bancassurance policy: the names differ and the structure is consistent. A single premium, often around 5 or 6% of the amount borrowed, paid at drawdown, frequently added to the loan.

What it costs, properly measured

On the 2.4 billion dong, twenty year loan used throughout this site, a 6% single premium is 144,000,000 dong. Against total borrowing costs of roughly 2.68 billion dong that is about 5%, which sounds minor. Measured as a rate, it is not minor at all.

One premium adds 1.25 percentage points to the price of the loan, for the whole twenty years. To put that in perspective, negotiating the margin down by 0.3 points is worth 0.27 of a point, so this single decision is close to five times as large as the negotiation borrowers spend all their energy on, and it is settled in a five minute conversation at the end of a process everyone wants to finish.

Why upfront money is so expensive

This is the part worth internalising, because it applies to every upfront charge and not just to insurance.

Money that leaves on day one is money you borrow for the full term. If the premium is added to the loan, you are literally borrowing it at 11.5% for twenty years. Even if you pay it from savings, the effect is the same in opportunity terms: you received 144,000,000 dong less than the loan says you did, but you repay as though you had received it all.

The general rule follows directly. A charge of X% of the loan taken at drawdown costs roughly X divided by five in percentage points of effective rate, on a twenty year loan. Six percent upfront is about 1.2 points; three percent is about 0.6. Use that to convert any upfront fee into something you can compare against the margin, which is the only sensible way to argue about it.

Is the cover itself worth anything?

Frequently yes. A household with a single earner, a twenty year loan and dependent children has a real exposure, and the policy pays the outstanding balance if that earner dies or becomes permanently disabled. The objection is not to the cover. It is to three specific features of how it is sold.

1. The single premium structure. An annually renewable term life policy of equivalent cover, bought separately, is usually far cheaper in present value terms, and it can be cancelled if circumstances change. A single premium is spent whatever happens.
2. Cover that falls while the premium does not. Many credit life policies pay the outstanding balance, which by year fifteen is a quarter of what it was. You paid once, at the start, for cover that shrinks every month.
3. No refund on early settlement. Settle the loan in year three and you have paid twenty years of premium for three years of cover. Ask specifically whether the unused portion is refunded, and get the answer in writing.

Is it compulsory?

There is an important distinction here, and it is worth being precise about it rather than cynical.

• Property insurance is usually a genuine condition. The bank holds the property as security and requires it to be insured against fire and similar risks. That is normal, legitimate, and generally cheap.
• Credit life cover on the borrower is usually not a condition of the loan itself, but it may be a condition of the particular promotional rate you were offered. That is a legitimate commercial structure and it is also easy to present in a way that leaves the borrower believing they have no choice at all.

So the question to ask is not “is this compulsory?” It is:

What is the interest rate on this loan if I decline the insurance, and what is it if I accept? Please put both on the offer sheet.

Once you have those two numbers you have a priced choice rather than a vague pressure. Run both through the loan inspector: enter the insurance percentage in one scenario and the higher rate in the other, and compare the effective rates. Quite often declining the insurance and accepting a 0.2 point higher rate is substantially cheaper, and occasionally it is the other way round. Either way it stops being a matter of opinion.

Five questions before you sign the policy

1. Is the premium a single payment or annual, and is it financed as part of the loan?
2. Does the sum insured fall with the outstanding balance, or is it level for the term?
3. Is any part of the premium refunded if the loan is settled early?
4. Who is the beneficiary: the bank, or your estate with an assignment to the bank for the outstanding balance only?
5. What are the exclusions, particularly for pre-existing conditions, and what is the waiting period?

The one to compare against

Before accepting a single premium policy, get one quote for standalone term life cover with a sum assured equal to the loan and a term equal to the loan, from an insurer that is not the bank. It takes an afternoon. Whatever you decide afterwards, you will be deciding rather than accepting, and the difference between those two is frequently a hundred million dong.

Everything else that turns up at drawdown, and the order it turns up in, is catalogued in reading a bank offer sheet.