Anytime you borrow money, you’re assuming a certain amount of risk. And the larger the loan, the greater amount of risk you’re taking upon not only yourself, but also others. To mitigate that risk, some borrowers enroll in credit life insurance when taking out a loan.
In this article, we’ll examine what credit life insurance is, its cost, alternatives to credit life, and some parameters you can use to determine if credit life insurance is right for you.
Credit life insurance is a type of credit insurance that pays off your loan if you die before the debt is settled. The policy’s face amount is tied to the loan amount; as you pay off the loan, the face amount will decrease. If you die before paying the loan balance, the life insurance policy will serve to repay the outstanding debt.
Credit life insurance is primarily for the benefit of the lender. The lender is almost always the policy’s beneficiary, not your heirs. You’re responsible for the premium payment, which stays the same throughout the life of the policy even though the death benefit is getting smaller.
Other types of credit insurance also repay loans while you’re alive, such as disability, involuntary unemployment, leave of absence, or theft or destruction of property.
Credit life insurance was designed to cover many different types of loans, such as mortgages, auto loans, student loans, bank credit loans, and other types of loans. To prevent fraudulent claims or keep a lender from profiting unnecessarily from someone’s death, life insurers typically limit the face amount of insurance to be equal to or less than the loan amount.
Some states also set a maximum coverage limit on credit life policies. In New York state, face amounts on credit life policies are subject to a limit of $220,000. If the loan amount is greater than that, you may need to take out an additional individual policy or use another policy you own to cover the difference.
Credit life insurance is not mandatory. It’s not required that you buy it when you take out a loan, and it’s against the law for lenders to reject your loan application based on your refusal to purchase a credit life policy. Lenders also can’t attach a credit life insurance policy to a loan without your knowledge and written consent.
Premium rates for credit life are calculated based on the size of the loan, the type of loan, and the state where the loan was originated. Credit life’s rates are typically higher than for other types of life insurance for two reasons:
- Coverage is typically guaranteed to be issued, regardless of your health status. Because insurance companies don’t know the amount of risk they’re assuming when you purchase the coverage, they’re at greater risk of financial loss with a credit life policy, and they charge accordingly. In some cases, your age, health, and employment status can impact your eligibility.
- Lenders will sometimes include the insurance premium with the loan payments. This may sound like a good idea, but it is actually to your disadvantage financially because you’re borrowing money to pay the life insurance premium, which increases the amount of interest you pay.
Premiums are higher for a healthy person than if that individual was to purchase a term life insurance policy independently. For example, a 30-year-old would pay $370 per year for a $50,000 credit life policy but only pay $78 per year for the same face amount of term life insurance.
Depending upon the lender’s cancellation policy, you may be able to cancel your coverage and receive a refund for unused premiums. This can be useful if you have paid off the majority of your loan and you don’t wish to continue paying high premium rates for a lesser amount of coverage.
When you’re contemplating taking out a credit life policy, it’s wise to consider these other alternatives available to you before you buy the policy being offered to you.
Existing life insurance you own
If you already own a term or permanent life insurance policy, you may want to use that policy to cover your loan. A lender may want to see proof of coverage before they proceed with the loan. Keep in mind that you purchased that policy for a specific reason, so you’ll want to feel comfortable using some of the death benefit to cover your new loan.
Term life insurance
As mentioned earlier, term life insurance is a better buy than credit life insurance cost-wise. But, it’s also a better buy because the death benefit remains constant throughout the length of the policy and doesn’t decrease as it does with credit life insurance. With a term policy, you’ll also be able to name your beneficiary, and they can ultimately decide how they want to spend the death benefit.
Savings or investment account
If you have ample funds in a savings or investment account to cover the loan amount, if you were to die and you don’t mind allocating them to pay off the loan, you may be able to avoid buying credit life insurance.
If the primary reason you’re considering buying credit life insurance is to keep your heirs from inheriting your debt, you probably don’t need it because your debt rarely will pass to your heirs when you die; your estate settles your debts. If your estate can’t cover the amount you owe, your family members are typically not required to pay it.
However, there are several instances where a credit life policy can positively impact your estate planning:
- You don’t want your estate to settle your debts. Credit life insurance can cover the difference between the sales value of the item you borrowed money for, a car, for instance, without reducing the amount left to your heirs.
- You want to protect co-signers. By paying your loan in full, the person who co-signed the loan with you won’t be burdened with the remaining debt.
- You live in a community property state. In community property states, both your assets and your debts will typically pass to your spouse. A credit life insurance policy will pay off the loan, so your spouse won’t have to.
Credit life insurance can pay off your loan if you die. But, there are often better alternatives to buying it that accomplish the same purpose for a fraction of the cost. Carefully examine the details of any credit life insurance policy you’re considering, and remember that it’s not mandatory that you buy it.
Having grown up in upstate New York, Bob Phillips spent over 15 years in the financial services world and has been making freelance writing contributions to blogs and websites since 2007. He resides in North Texas with his wife and Doberman puppy.
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