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Loan protection insurance: What to know in 2022

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If you’ve ever taken out a mortgage, bought a car, or have one or more credit cards, the chances are good that you’ve been solicited to buy loan protection insurance. Similar to other types of insurance like whole life or supplemental health insurance, loan protection insurance has its advocates and its critics.

In this article, we’ll look at what loan protection insurance is, how it works, how it’s used, its pros and cons, and alternatives to loan protection insurance. Read on if you’d like to know if buying loan protection insurance is a smart move for you.

What is loan protection insurance?

When you apply for a loan, your lender may offer you loan protection insurance, also known as credit protection insurance. The purpose of these policies is to make your monthly payment for you if you can’t work due to a disability or unemployment.

Lenders offer loan protection insurance for two reasons:

  1. It provides them with a guarantee that your loan will be paid off, either by you or by the insurance company issuing the policy
  2. They make money when they sell a loan protection insurance policy

Though lenders can offer you this insurance, they can’t require you to purchase it as a condition of being approved for your loan. They also can’t include insurance in your loan without your knowledge and without disclosing the fees associated with the policy.

Depending on the insurance carrier, loan protection insurance may or may not include debt payoff in the event of your death (life insurance).

How does loan protection insurance work?

Most consumers have two types of loans: open ended-loans and closed-ended loans. Loan protection insurance works a little differently with each of these loan types.

Open-ended loans, such as credit cards, limit the amount you can borrow, but they don’t have a fixed loan amount or a repayment timeline. Your balance typically varies from month to month, as does your minimum required payment amount.

On these types of loans, your monthly rate for loan protection insurance will vary, depending on your current balance.

Closed-ended loans, such as mortgages and car loans, have a fixed loan amount and a specific repayment timeline. (For example, your mortgage payment is probably for a 15 or 30-year term and is based on the purchase price of your home).

Companies that sell loan protection insurance for closed-ended loans will either charge you a one-time fee for your coverage when you take out the loan or add monthly premium payments to the loan itself.

Loan protection insurance usually has a 60-day waiting period from when the qualifying event occurs, such as becoming disabled or unemployed, and the benefit period lasts 12-24 months.

Some policies also have restrictions like waiting periods before you’re protected after buying the coverage, they won’t pay benefits if you have a co-signer, or they have maximum payout limits.

Types of loan protection insurance

Lenders for various types of loans offer loan protection insurance.

Auto loan protection insurance

Auto loan protection insurance will make your monthly vehicle purchase or lease payments if you become sick or injured, or if you become unemployed.

Personal loan protection insurance

Personal loan protection insurance makes your monthly installment payment if you become disabled or lose your job.

Business loan protection insurance

Business loan protection insurance provides protection for loans taken out for business-related expenses, such as:

  • Equipment purchases
  • Expanding a business or practice
  • Facility renovations
  • Inventory purchases or increases in working capital

Learn More: Business Overhead Expense Insurance

Mortgage loan protection insurance

Mortgage loan protection insurance although people usually think only of mortgage life insurance to pay off their mortgage if they die, some insurers will make your payments in the event of unemployment or disability.

Learn More: Mortgage Disability Insurance

Pros & cons of loan protection insurance

Loan protection insurance has its pros and cons:

Pros

  • Will help you maintain your credit score by preventing delinquent payments, which lenders report to credit bureaus.
  • Takes pressure off of you and provides peace of mind by making your loan payments if you can’t.

Cons

  • Is expensive compared to stand-alone disability and life insurance policies.
  • Has a limited benefit period during which the insurer will make your payments (12-24 months). If your disability or unemployment lasts longer than this, you still risk defaulting on your loan.
  • Isn’t beneficial if you default on a loan because of financial insolvency and/or bankruptcy.
  • Most loans that are only in your name and don’t have a co-signer cannot require your family to make your loan payment if you’re unable to. If you’re not worried about your assets going to creditors, loan protection insurance may not be worth it.
  • Some policies contain fine print and won’t pay a benefit under certain circumstances, including self-employment, part-time work, pre-existing medical conditions, being able to work another type of job, or short-term contract work ending.

Alternatives to loan protection insurance

Before you purchase loan protection insurance, consider these alternatives that can provide better protection:

Long term disability insurance

Long term disability insurance can cover you for a much longer period (up to age 65) than the much shorter-term benefits loan protection insurance policies provide.

Long term disability policies can also provide a much larger benefit payment (typically up to 2/3 of your income) which will not only make your loan payment(s), but will provide the money you need to pay other ongoing expenses (mortgage/rent, utilities, food, clothing, etc.).

Benefit payments for long term disability insurance come directly to you, unlike benefits for loan protection insurance which are paid directly to the lender. This gives you and your family the freedom to choose the best way to spend your benefits.

Get a long term disability insurance quote in seconds.

Critical illness insurance

Critical illness insurance pays you a lump-sum cash benefit that can help you make loan payments for a longer term than a loan protection insurance policy. Payments, made directly to you, can range from $5,000 to $75,000 or even higher.

Critical illness insurance policies pay benefits for illnesses such as:

  • Cancer
  • Heart attack
  • Stroke
  • Paralysis
  • Coma
  • Alzheimer’s
  • Bypass surgery
  • Angioplasty
  • Kidney failure
  • Organ transplant

Individual critical illness policies also allow you to customize your policy and choose benefits for various conditions, depending on the carrier.

Curious what critical illness insurance costs? Check your rate here.
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Life insurance

If you’re not concerned about making monthly loan payments but want to have your loan paid off if you die, life insurance is an alternative worth considering.

You can choose from an inexpensive term life insurance policy that will stay in force until your loan is paid in full (i.e., a 30-year term life policy for a 30-year mortgage) or a permanent life insurance policy (whole life, universal life, etc.) that will pay off your loan balance and build cash value.

Is loan protection insurance worth it?

In most cases, loan protection insurance is not the most effective way to ensure you can make your loan payment. Short-term and long-term disability insurance policies offer better protection and are more cost-effective, as do critical illness insurance or other supplemental insurance policies.

If you decide to accept your lender’s offer for loan protection insurance, be sure you know all of the policy’s terms, conditions, and exclusions (many health-related issues are excluded from coverage).


The information and content provided herein is for educational purposes only, and should not be considered legal, tax, investment, or financial advice, recommendation, or endorsement. Breeze does not guarantee the accuracy, completeness, reliability or usefulness of any testimonials, opinions, advice, product or service offers, or other information provided here by third parties. Individuals are encouraged to seek advice from their own tax or legal counsel.

Insurance
Published May 13, 2022