Protection plan is a luxury, not a necessity

The news that the Irish Financial Services Regulatory Authority (IFSRA) is investigating why AIB charged 570 mortgage customers for payment protection cover without their approval should spur homeowners to check whether or not they are paying for such policies and whether or not they actually need them.

Would-be first-time buyers may also be prompted to ask: what exactly is a payment protection plan anyway?

First off, payment protection is not to be confused with mortgage protection. The latter, compulsory in the Republic for homeowners under the age of 50, is a life assurance policy that will usually clear a home loan in the event of the death of either of the homeowners.

It does not have to be purchased from the lender but can be obtained from any life assurance company or through a broker.

Payment protection, however, is very much an optional extra that can be signed up for by people borrowing by way of personal loans, credit cards and car loans as well as mortgages.

Payment protection plans will mean that the loan repayments are met in the event of accident, illness or involuntary unemployment.

The repayments are covered for 12 months, but usually do not kick in unless the disability or redundancy lasts for more than the first month.

Some lenders, including Permanent TSB, stress that the only time to avail of the cover is at the time that borrowers are arranging their mortgage, making it seem like a "now or never" option.

AIB strongly recommends its payment protection plan, saying it will provide borrowers with complete peace of mind.

"You might never crash your car, but it's still reassuring to know that you have an airbag," the bank says.

According to its website, the plan is "great rainy day insurance" that is "well worth the modest extra cost".

So how much does it cost?

On AIB credit cards, the charge is 60 cent for every €100 on the outstanding balance.

On AIB mortgages, it costs €4.75 for every €100 of the borrower's monthly repayments. On Permanent TSB home loans, it costs €4.50 per €100.

On a €250,000 loan to be repaid over a 25-year term, monthly repayments will be €1,224 without payment protection.

With payment protection for one borrower, this repayment jumps to €1,282, according to AIB's online repayment calculator. If both joint borrowers are covered, the monthly repayment is €1,340.

This means that a single customer will pay an additional premium of €697 every year for payment protection, while joint borrowers where both parties are insured will be coughing up €1,395 more.

It is thought that about one in every five people take out payment protection on car loans, although it is not known how many do so on mortgages.

Many first-time buyers who are stretching to make the repayments on the largest possible loan they can squeeze out of the bank will probably want to avoid additional costs, yet may be nervous about taking on such a large debt without safety nets.

Brokers are wary of lenders' attempts to foist payment protection on borrowers.

Mr John Geraghty, chief executive of LABrokers.ie, believes homebuyers are being bombarded with "unnecessary extras" at a time when they are scrimping and saving to buy furniture.

"Mortgage protection is the minimum requirement you must have. In addition to that, the lender will try to sell as many add-ons as they can which will help them meet their sales targets and bump up the premium for the borrower," according to Mr Geraghty. "At the point-of-sale, it should be stressed that this is optional."

Mortgage holders, especially single borrowers and single-income families, will understandably worry about what might happen to their home should the person responsible for the repayments get sick.

These borrowers can also investigate the option of purchasing enhanced mortgage protection insurance that will pay out in the event of a critical illness, rather than buying payment protection.

Critical or serious illness insurance will pay out a lump sum following the diagnosis of a specific set of conditions, instead of simply covering 12 monthly mortgage repayments.

But payment protection policies and critical illness insurance are usually tightly underwritten.

"There are lots of exclusions. If most people knew about them they wouldn't take the policies, because they are so restrictive," says Mr Geraghty.

"It's open to interpretation. You might have cancer, but if it's not invasive, the policy might not pay out because the insurer will say you got it in time and it didn't invade the surrounding tissue. Or you might have a heart condition and the doctors will tell you to take it easy, but the policy won't cover angina."

Under AIB's mortgage payment protection plan, critical illness is defined as "cancer, coronary artery by-pass surgery, heart attack, kidney failure, major organ transplant, stroke or loss of a limb or sight diagnosed by a doctor".

The insured person does not have to suffer one of AIB's seven specified critical illnesses in order for the policy to cover the mortgage for 12 months, as the plan also pays out in the event that sickness or disability prevents the person from working.

In some cases, an injury or illness might prevent the insured person from doing their job - for example, operating a machine or working at a computer for long periods - but they may be capable of doing other jobs.

But the terms state the disability must stop the customer from doing both their work or "any work that the insured person's experience, education or training may reasonably qualify the insured person to do".

This is one grey area that could lead to claims being rejected.

Mr Geraghty advises that all borrowers make sure they get an opportunity to read the terms and conditions of any policy before they buy it.

It can be difficult for customers to work out exactly how much they are paying and for what, he says.

"There might be one direct debit of €1,000 and €800 is the main mortgage repayment and €200 is for insurance, but they don't know the breakdown between home insurance, mortgage protection and payment protection for accident, illness and redundancy," he says.

"It's very hard for someone to come back in two or three or four years' time and see what they are paying for because they don't see it itemised on their statement," says Mr Geraghty.

He advises that borrowers ask their lender for a breakdown of all the payments that they are making.

Main monthly repayment

Make sure that your repayments are based on the correct term as agreed at the time of approval and that you are on the correct interest rate i.e. a fixed rate or standard variable rate.

Ask to switch to the lender's tracker interest rate, which is cheaper but may only be promoted to new customers.

The lender may refuse, at which point there's no harm in checking if there are lower interest rates available at other lenders. Remortgaging could save money in the long term.

Mortgage protection

This is compulsory for borrowers under the age of 50. Some lenders require that people over 50 who refuse it sign a declaration saying they have been advised of its benefits.

Make sure to shop around: the insurance company your lender uses may not be the cheapest.

Mortgage protection clears the outstanding balance in the event of the person's death.

As the outstanding balance decreases as the person makes repayments, so does the sum insured.

So the policy should be called "decreasing term assurance".

"Level term assurance" is more expensive, while a type of policy called "whole of life" will cost more again and may be neither suitable nor necessary.

Home insurance

Borrowers can shop around for home insurance and don't have to take the policy the lender offers. Some insurers - but not all - will charge extra if you want to pay your premiums by monthly direct debit. This can add up to 14 per cent more to the annual cost.

Homeowners should review their policy regularly to make sure they are insured for the correct sum. This is the cost of rebuilding the home, not its market value.

Information on rebuilding costs is available from the Society of Chartered Surveyors.