What Is Credit Life Insurance, and Do You Need It?
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There’s a certain degree of risk when you take out a loan, especially if you’re borrowing a lot of money. Protecting others from shouldering your debts if you die can be a natural concern. However, debts are rarely inherited, which means your loved ones probably won’t be responsible for your loan.
In some situations, though, your debt can have a negative impact on the ones you leave behind. Credit life insurance helps lessen these risks by repaying the lender if you die before paying off the loan. But this type of insurance isn't always necessary. Before you buy a policy, consider the costs and explore alternatives like term life insurance, which typically offers the same type of protection at a lower price.
What is credit life insurance?
Credit life insurance pays off your loan if you die before settling the debt. The policy’s face value is linked to the loan amount; as you pay down the debt, the coverage amount decreases. If you die before paying off the loan, the insurer repays the remainder of the debt.
Credit life insurance doesn’t really protect you as much as it protects the lender. Your premiums stay the same throughout the length of the policy regardless of how small the loan gets. And lenders are almost always the beneficiary of credit life insurance policies, which means the payout goes directly to them — not to your heirs — if you die.
Types of credit insurance
Credit life insurance is a specific type of credit insurance that pays out if you die. Other types of credit insurance repay loans in less extreme circumstances, such as involuntary unemployment, disability or destruction of personal property.
What does credit life insurance cover?
Credit life insurance can cover a range of loans, such as mortgages, auto loans or bank loans. In general, the amount of insurance can't be more than what you owe on the loan.
Your state may set maximum coverage limits for this type of insurance. For example, credit life insurance policies for mortgages in New York typically can’t exceed $220,000. Therefore, if your mortgage is $440,000, your credit life policy can cover only half of the loan.
In general, credit life insurance is sold by banks or lenders when you take out a loan. But you’re not typically required to purchase coverage if you don’t want it. In fact, lenders typically can’t reject a loan application based on the borrower’s refusal to purchase optional credit insurance. It’s also illegal for lenders to include credit life insurance in your loan contract without your knowledge or consent.
Alternatives to credit life insurance
When shopping for loan insurance, credit life isn’t your only option. Consider the following alternatives before buying a policy.
Credit life insurance vs. term life insurance
You can use a standard term life insurance policy to cover your loans. This type of coverage is typically cheaper and more flexible than credit life insurance. A term life death benefit often stays the same throughout the length of the policy and pays out regardless of how much you owe on your loan.
Also, you can choose a life insurance beneficiary for your term policy. This means the people or entities you choose — not the lender — receive the money, no matter how much of the loan you’ve paid off, and they can use the funds for any purpose.
Existing life insurance policies
Instead of buying more coverage, you can use an existing term or permanent life insurance policy to cover a loan. But make sure you’re comfortable allocating some of the funds from the existing policy to cover the loan, especially if you bought the policy to cover specific expenses.
Traditional savings account
Existing savings or investment accounts can be a great financial safety net. If the funds in your savings account can help cover any outstanding debts after you die, you may not need insurance.
Is credit life insurance right for you?
You probably don’t need credit life insurance if your only concern is debt inheritance. That’s because your debt rarely passes to your heirs when you die. Instead, your estate settles your debts using your assets. If there’s not enough money to cover what you owe, the debt typically goes unpaid, and family members are not required to pay it.
However, there are times when an outstanding loan can have a negative impact on your estate planning. Life insurance can be a useful tool in the following scenarios.
You don’t want your estate to pay your debts. When you die, the asset you borrowed money for — such as a car or house — may be sold to repay the lender. This can reduce the amount left to your heirs. Loan insurance covers any outstanding payments if you die, keeping the debt out of your estate.
You want to protect co-signers. When you co-sign a loan, you’re equally responsible for the debt. Credit life insurance pays any outstanding debt if you die, removing the burden from any surviving responsible parties.
You live in a community property state and want to protect your spouse. In states with community property laws, your assets — and your debts — typically pass to your spouse. A credit life insurance policy pays off the loan so your spouse doesn’t have to. Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin are states with community property laws.
How much does credit life insurance cost?
Credit life insurance premiums vary and are based on the size and type of the loan. The costs can be higher than for other life insurance products because of two key factors:
Coverage is typically guaranteed, regardless of your health. As with most guaranteed issue life insurance policies, insurers generally charge higher premiums when they don’t know your medical history because the risk to insure you increases. Not all credit life insurance policies are guaranteed. Your age, health and employment status may affect your eligibility.
Lenders sometimes roll insurance premiums into the loan payment. This might sound like a good idea, but it can end up costing you more. You’re essentially borrowing money to pay your insurance premiums, which increases the interest you pay.
Below are sample annual rates for $50,000 term and credit life insurance policies for a person in good health, based on data from the Wisconsin Department of Financial Institutions.
Can you cancel credit life insurance?
You may be able to cancel your coverage and receive a refund on your premiums if you need to terminate a credit life insurance policy early. However, cancellation policies vary among lenders. The ability to cancel your policy can be useful if you pay down most of your loan and don’t want to continue paying the same premium for less coverage.
Before you buy a policy, ask whether you can cancel coverage early and what type of refund policy, if any, is available.