Real estate loan: watch out for the declining insurance trap

Taking out a real estate loan does not only mean repaying the amount borrowed over several years and paying the interest on the loan. The bank also requests to take out borrower insurance, paid monthly, so that in the event of the death of the borrower, disability or even loss of employment, the insurer will reimburse in its place.

all or part of the remaining deadlines

all or part of the remaining deadlines

To set the insurance premium, there are two calculation methods, one based on the initially borrowed capital (CI), the other on the capital remaining to be repaid (the capital remaining or CRD). Insurance on CI is more widespread. In this case, the insurer applies a rate on the amount borrowed, to obtain the annual premium, then divides it by 12 to obtain the monthly premium. The result, the monthly payment of the insurance remains fixed during all the duration of the mortgage.

On the other hand, with insurance calculated on the capital remaining to be reimbursed, the monthly contribution decreases over time. This is why we speak of progressive insurance. Indeed, with each monthly payment of credit, the capital must still be reimbursed.

This amount serves as the levy base for insurance. As a result, as the borrower repays the loan, the insurance premium decreases. It may happen that periodically, every year or every 5 years, for example, the insurance monthly payment increases slightly, before declining again. This is due to the fact that companies sometimes apply a calculation that takes into account the age of the borrower, and the growing risk of a health concern.

Credit and insurance are nested in a single, fixed monthly payment

Credit and insurance are nested in a single, fixed monthly payment

This risk premium is not present in the aggressive borrower insurance launched in 2018 by the Good Finance group. On the other hand, this banking contract has its own specificity: imbricating the reimbursement of the mortgage with insurance and smoothing the overall maturity.

As a result, the borrower is debited every month in a single monthly payment which includes the amortization of capital, interest, and insurance. Without this smoothing, the gradual insurance would be added to the fixed installments of the loan and the first cumulative monthly payments would be more expensive.

In fact, this smoothed formula, a priori, more likely to hit the mark with borrowers. If conventional CRD insurance is becoming scarce, it is because it is more difficult to adapt to the financial reality of households. Over the years, they expect their income to increase and their repayment capacity to increase.

In this perspective, why tighten your belt today by paying more insurance, when with a constant expiry the cost of credit is better distributed over time! According to our information, it is precisely the difficulties in selling these decreasing borrowers insurance (without smoothing) which led several banks, including BNP Paribas and LCL at the turn of the 2000s, to give up the CRD contracts.

The double penalty in the event of early repayment

The double penalty in the event of early repayment

The borrower affected by the slowdown of capital. But this comparison is only valid if the borrower goes after his credit, which is rarely the case. Indeed, if the French take their mortgage more often over 20 or 25 years, they pay off their loan on average after 8 to 10 years. Or because they resell to buy bigger.

Or because they renegotiate their loan. Or, again, because a large cash inflow allows them to repay all or part of their credit in advance. The problem is that paying off faster than expected on your loan is less attractive with declining insurance. Since the premiums were raised at the start, the borrower at the time of his early redemption will in fact pay more for insurance than if he had opted for conventional cover.

This deleterious effect is increased tenfold with an arrangement smoothing the monthly payment of credit and decreasing insurance. Because, to be able to offer a constant overall monthly payment, the formula proposed by Good Finance plays on the repayment of the loan or, in banking jargon, on the amortization of capital.

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