WHILE consulting with a client, I recently discovered that there was a gap in the client’s insurance coverage on his property loans.
Basically, the client has a property loan for 30 years but it was paired with a mortgage reducing term takaful (MRTT) policy that only provided protection for 15 years.
The client told me that he was then advised by the loan officer that a shorter MRTT tenure would result in cheaper insurance premium, thus cutting down on the upfront costs to finance the property. In my experience, what the client went through is not unique to him. It is not uncommon for many property investors who:
- Seek to hold their investment properties for shorter periods; and/or
- Minimise financing costs of their investments to go for MRTT or mortgage reducing term assurance (MRTA) policies that are mismatched against the loan tenure. An insurance gap exists when there is a difference between the insured amount and the outstanding loan amount.
Let’s go back to home financing basics: what is MRTT/MRTA? MRTT is a takaful product while MRTA is an insurance product that pays out the agreed amount if you die or suffer from total permanent disability.
Both products ease the burden on the family so that they are able to pay off the existing loan on the home if the homeowner passes away.
A MRTT/MRTA is critical especially for a family home. When you have a full tenure/full amount MRTT policy, the MRTT pay-out tracks the loan outstanding on the home which reduces over time.
In other words, should the undesirable happen to the homeowner, the value of the MRTT will pay off the outstanding loan directly to the bank. Filling up the gap
In the case of my client which has an insurance gap on his property, he now has to think about how his family is going to afford to pay the remaining loan amounts if he dies.
In this example (Scenario D) of his 15 year MRTT, he will find that the MRTT pay-out reaches zero (maturity) 15 years before his loan outstanding reaches zero (30 years).
Depending on the value of the property, the difference between sum assured on the MRTT and the loan amount can be even in the hundreds of thousands of ringgit.
There are also instances of being under insured (Scenario E) whereby the loan amount is RM500,000 but sum insured is RM400,000. If the loan is not paid off, the bank may seek to repossess the property and auction it off.
For a grieving family, this may be emotionally difficult, especially if they have just lost the family breadwinner, and even worse, if the home being sold is the family own stay home.
Financially strong clients will have other sources of wealth that can be used to pay off these loans. They have a lifetime savings for example like Amanah Saham Bumiputera (ASB) or unit trusts that can be liquidated.
They may also have life insurance policies that can be used to pay off the loans too. The tricky bit in my experience, however, is the posthumous instructions or will/estate planning that instructs the family to pay off the loans before enjoying the fruits of the bequeathed wealth.
For Muslim families in particular, paying off one’s debt is of utmost importance and is clearly indicated in the Quran (4:12) “…. But if they leave a child, you get a fourth of that which they leave after payment of legacies that they may have bequeathed or debts….”
To conclude, if you have mortgages or have property investments, do take up the personal responsibility and the time to examine your MRTT or MRTA policies to see whether there are any gaps.
If there are, do plan ahead by doing estate planning so that you do not unnecessarily financially burden the family you leave behind. – May 8, 2022
Rozanna Rashid, CFP, IFP is a director and Licensed Financial Planner with Alpine Advisory Sdn Bhd.
The views expressed are solely of the author and do not necessarily reflect those of Focus Malaysia.
