What Is Credit Insurance?
Credit insurance ensures the lender continues to receive payments if you can’t make them. You probably don't need it.
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Contributing Writer When you take out a loan or use a credit card, you may intend to repay what you borrowed, but what if you can’t?
Some lenders offer credit insurance, also known as loan or payment protection insurance, as an extra layer of assurance. But it’s a costly add-on that may not provide much value to borrowers.
Here’s what to know about credit insurance.
What is credit insurance?
Credit insurance is an optional insurance policy offered by lenders and creditors to cover your loan or credit card payments if you cannot pay due to unemployment, illness, disability or death. It prevents you from defaulting on your loan if you’re no longer able to make the monthly payments.
Debt cancellation and suspension plans are similar in that they ensure the lender is repaid if you’re unable to make payments. However, unlike credit insurance, these products aren’t subject to state insurance regulations.
Credit insurance may seem to function like life or disability insurance, but there is a crucial difference: Credit insurance pays the lender directly, instead of you or your family.
Lenders may give you the option to buy credit insurance when you apply for an auto loan, unsecured personal loan or credit card.
Most borrowers don’t need credit insurance if they have existing insurance policies in place.
Types of credit insurance
There are four main types of credit insurance coverage:
- Credit life insurance: Makes the remaining loan payments to the lender in the event of your death. These policies sometimes have a payout limit, which may be less than the outstanding loan balance.
- Credit involuntary unemployment insurance: Makes a limited number of monthly payments to the lender if you lose your job through no fault of your own. You’ll typically need to be unemployed for a certain amount of time (often 30 days) before this coverage kicks in.
- Credit disability insurance (also known as credit accident and health insurance): Makes a limited number of monthly payments to the lender if you become disabled or ill. Most policies require that you be out of work for a specified amount of time (like two weeks or 30 days) before they’ll make payments on your behalf. These contracts sometimes exclude pre-existing conditions, meaning the insurer can refuse to pay your claim if your disability is caused by a medical condition you were diagnosed with before buying the policy.
- Credit property insurance: Pays out if the property used as loan collateral is damaged, destroyed or stolen. This coverage is unique in that it doesn’t kick in if you become unable to make payments; instead, it’s the destruction or theft of the property that triggers the payout. Credit property insurance only protects your lender’s interest, not yours. Unlike the other three types of credit insurance, which are optional, lenders are allowed to require this coverage as a condition of the loan. However, you have the right to shop around instead of buying a policy directly from your lender.
A lender may bundle different types of credit insurance into a single offering.
How much does credit insurance cost?
Usually, credit insurance costs about 1% to 5% of your monthly loan payment, though the exact cost varies based on the type of loan, type of insurance, loan amount and the state where you live. The price is also influenced by the commission that insurers pay lenders.
There are two main ways your premium can be calculated:
- Single premium method. The premium is calculated upfront at the beginning of the loan. You’ll then pay interest on both the loan principal and the insurance premium.
- Monthly outstanding balance method. Your premium is automatically recalculated each month based on your outstanding balance. This method is more common for revolving credit, like credit cards, personal lines of credit and home equity lines of credit (HELOCs).
Regardless of the method used to calculate the premium, you can expect a higher monthly loan payment if you purchase credit insurance than you’d pay if you opted out. A 2018 report from The Pew Charitable Trusts found that credit insurance increases borrowing costs by more than a third.
Credit insurance premiums are typically more expensive than other insurance premiums. Moreover, these policies provide smaller benefits, and the payout goes to your creditors instead of you or your survivors.
Is credit insurance required?
Credit insurance is not required to get an unsecured personal loan or credit card. If you’re denied a loan for not signing up for credit insurance, you can report the lender to your state insurance department, state attorney general, the Consumer Financial Protection Bureau (CFPB) or the Federal Trade Commission (FTC).
Lenders also aren’t allowed to sell you credit insurance without your permission. When you apply for a loan, ask your lender whether your payments include optional credit insurance before you sign the agreement.
If you’re currently paying for credit insurance, you have the right to cancel coverage at any time. You may also be entitled to a partial refund of your premiums if you pay off your loan early.
If you’re struggling to make loan payments, ask your lender about hardship assistance. Some lenders allow you to defer payments or may temporarily modify your loan agreement.
Alternatives to credit insurance
NerdWallet does not recommend taking credit insurance if you already have a traditional disability or life insurance policy that will cover your obligations if something goes wrong. Consider these credit insurance alternatives before you purchase a policy:
- Term life insurance. This type of life insurance provides a payout to your loved ones (not your creditors) if you die during the window in which the policy is in effect. Your survivors can then decide the best way to use those funds.
- Disability insurance. A disability policy can replace part of your income if you can’t work due to an illness or injury. Payments go to you, rather than your lender. You can decide whether that money goes toward your debts versus other expenses.
- Emergency savings. You could use the money you would have paid for credit insurance to build an emergency fund. Building up your savings can help you make payments during an income gap or unexpected shortfall.
- Lender hardship programs. Though they aren’t exactly an alternative to credit insurance, lender hardship programs may allow you to skip or reduce loan payments in some situations, like if you lose your job or become disabled. Approval is often granted on a case-by-case basis, but if you’re worried you wouldn’t be able to make your loan payments in an emergency, it’s worth checking with a potential lender about their policy.
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