Part 2: How Loans protect your family better than Life & Education Insurance

This may sound absurd, because, “Don’t loans take money away from you? If I lose my job, won’t the bank wipe me out? How can these loans protect me? More so, how can it protect me better than insurance plans?”

Loans on assets actually offer better protection than what insurance companies offer you as an individual.

This truth dawned upon me recently when I was making inquiries at banks to finance the purchase of a piece of property.
I was just as surprised as you probably are, but boy am I glad that I got to learn this early on! And to also learn that loans (for assets) aren’t so scary after all. Other loans though may prove to be dangerous.

Loans (for assets) aren’t so scary after all

We will use this table below for comparison purposes. It represents some insurance packages offered by a renowned insurance company in Kenya.

If you’re a newbie to insurance i.e. if you don’t understand something in this table below, you can follow this link (Part 1: Life Insurance Starter pack) to learn the basics.

First things first: Whenever you take a loan with a bank, they insure that loan with a Credit Life insurance cover (which is far cheaper than the normal Term Life insurance cover). This means that, if you die, the insurance company will pay the bank, the amount that you owed the bank. That means that your family is not left with the burden of repaying that loan.

If you die, the insurance company will pay the bank, the amount that you owed the bank. Your family won’t be left with that burden.

1. Loans on Assets offer better insurance than basic life insurance

We’ll consider an asset in this article as any form of real estate. Real estate is something that hardly ever depreciates. And it often appreciates at a faster rate than inflation. So we can define an asset in this case as houses, apartments, commercial property, farmland etc.

To give an example:

To get a sum assured of Ksh. 7,000,000 for a mortgage you only need to make a yearly insurance contribution of Ksh. 39,000 which loosely equates to Ksh 3,250 per month.
Compare this to the table above where the monthly contribution is Ksh 5,000 (sh60,000 yearly) for a sum assured of Ksh. 5,813,000.

This simply means, that you get a higher sum assured for a lower monthly / yearly contribution. “WHAAAT?!”, YES, IT’S TRUE.

Why is it cheaper? The insurance companies consider the cover that they offer to the bank’s borrowers to be less risky due to factors such as: the bank has carried out extensive due diligence on you, the bank factors in your income whereas basic insurance doesn’t always do that.

2. Loans on assets protect you against INFLATION

Pay attention to this one — it’s not a common truth. We’ll use an example to unpack this one:

You get a loan to buy land / house that costs Ksh 2,000,000. Some crazy inflation hits the country as it did in Kenya in the early 1990's whereby the prices of property rose 3 to 4 fold within a period of 3 years. Treasury Bills and Bonds rates were also crazy — above 60% ; and interest rates on loans had gone above 30%. And the saddest part is that many people’s salaries stayed stagnant during this inflation.

So what happens? Well, your property is now worth Ksh 6,000,000–8,000,000. But the amount that you owe the bank is still Ksh 2,000,000. To gain from this “blessing called inflation”, you can sell the property, use the change to buy other slightly cheaper property with cash i.e. no debt! This example is extracted from a real life example of people that I know personally.

Your eyes may have popped at interest rates going above 30%, yes, that’s alarming, but banks can’t commit more than 66% of your salary/income to loan installments.

You no longer fear inflation, in fact, you welcome it with open arms!

With loans on assets, you not only protect yourself with insurance cover, you also protect yourself from INFLATION!
You no longer fear inflation, in fact, you welcome it with open arms!

3. Protection against RETRENCHMENT

If you are retrenched, and thus left with no income but you still have a loan, the insurance company can pay your monthly loan installments on your behalf for the next 9 months! And you don’t have to reimburse them!
So your debt is reducing, your asset is increasing in value and you have a fairly good runway to look for another job.
Be keen on the insurance cover on your loan, some don’t have this retrenchment cover.

If you are retrenched, then the insurance can pay your monthly loan installments for the next 9 months!

Think about the other case whereby you had only taken Life insurance — your cover is virtually “paused” or your sum assured & bonuses may be reduced.

You’re probably asking “Okay, I get that. But what if things really go south to the point that I don’t find another good job within those 9 months?” — if things go terribly wrong, then the great fall back is that you have an asset in hand (that probably appreciated in value) which you can sell, pay the bank the money that you owe them and you keep the balance.

Banks aren’t quick to take possession of your property

Banks aren’t quick to take possession of your property — that is only a measure of last resort. They first try to work out better terms that will make it more comfortable for you to pay back your loan. If that doesn’t work, they usually request you to sell the asset so that you can pay them back and thus keep the change. If this doesn’t work, then that’s when they storm in to auction your property to recover their money.

4. Protection against YOURSELF

Maintaining the discipline to save up money every single month for an investment goal that is way out in the future isn’t the easiest thing for everyone to do. Loans on assets help you maintain discipline to consistently contribute towards an investment goal.
There are needs and desires that come up to compete for your money e.g. fundraisers, a holiday, add something small to your car or house, a nice flashy business idea etc.

Loans on assets help you maintain discipline to consistently contribute towards an investment goal.

When you try to save up money for a piece of property by putting money in a Savings account or MMF, there’s no obligation to do so other than your own personal will. This is where the temptation to channel that money to other things checks in.

There’s no obligation to consistently put money in your Savings / MMF account other than your own personal will.

If you’re disciplined enough, saving up to purchase the property may work well for you — though you don’t gain from the protection offered by insurance on loans. For example:

If you planned to save money for 3 years to buy some property and you die in the 5th month of saving, your family will only get the money that you had saved up to that point. But if you had taken a loan to buy that property, then you die on the 5th month of loan repayment, the insurance company would pay for the rest of the loan, and your family gets that property debt free.

If you know that you might slip up here and there, or you want that added protection, then a loan on an asset is a great way to go for you!

5. Monthly insurance contribution reduces while asset value grows

As you pay off your loan each month, likewise, the debt amount is reducing each month. This therefore means that that insurance cover that you’re taking on your loan is reduces each year. Yet, the value of the asset that you’ve taken on loan is increasing in value each year! To use insurance-like terminology: it’s like saying that your monthly insurance contribution is reducing, but your sum assured is increasing in value.

If we’re to look at it from another angle i.e. in the case that you don’t die and you had taken a loan for an asset:

The capital gains on the property (the increased value of the property) during this term is usually equal or more than the interest paid over the duration of the loan term. The insurance cover throughout this period decreases each year since the debt amount keeps reducing. At the end, you have an asset with great value, that you could sell if you really want to have cash in hand.

You can compare it to taking an Endowment package in the case that you didn’t die during the term.

Conclusion

Lastly, as you may have realised, both options Life Insurance and loans on assets are long term commitments. We therefore have the need to grow as well as protect the interests of our families.

This article was focussed on insurance and therefore protection, not growth or investments. That’s a topic for another day. But if you do want to protect your family, I would therefore suggest a 2 pronged approach for protection:

1. Take a loan on an asset that you can comfortably afford (you don’t have to live in that house / on that property) — in the case of your demise, ownership is fully your family’s. If the asset is a house, they only need to look for food. If you survive, then you have an asset at your disposal. An asset is a powerful tool that unlocks cheap financing that allows you to invest in other projects or to acquire other assets.
2. Take a loan on an asset that earns some passive income e.g. farm land or a house to rent out — in the case of your demise, your family will now have an asset plus some passive income. Thereafter, they’re only looking for extra money to make their life a little more comfortable. If you survive, well, you have an asset plus some passive income flowing in.