Table of Contents
Table of Contents
When you take out a loan, you intend to repay it over time. But if you pass away unexpectedly, that burden could fall to your family members. To help avoid this problem, you could set up credit life insurance when applying for your loan.
While they may be convenient, such policies do have some drawbacks compared to regular life insurance. Consider how this type of credit insurance works and compares to other options.
Understanding Credit Life Insurance
Credit life insurance is a life insurance policy connected to a specific debt, such as a mortgage, car loan or line of credit. If you die before paying off the debt, the credit life insurance policy pays out a death benefit. The death benefit goes toward paying off your remaining loan balance. That way, your lender gets its money back, and your beneficiaries avoid having to take over repaying the debt.
How Does Credit Life Insurance Work?
Credit life insurance works by matching life insurance with the repayment schedule of your debt. You first pay to set up the life insurance. Some policies charge one single premium. Your lender could build this cost into your loan. For example, if you take out a $100,000 loan and the credit life insurance costs $6,000, your total debt would be $106,000. Other credit life insurance policies may charge ongoing monthly or annual premiums.
The total coverage for credit insurance usually matches the amount of your remaining debt. As you pay down the debt, you owe less, so you need a smaller death benefit to cover the outstanding loan amount. Credit life insurance protection is temporary. Once you finish paying off the debt, the policy ends.
What Does Credit Life Insurance Cover?
Credit life insurance lays out which debt it covers and would pay off with the death benefit. Some common debts covered by credit life insurance include:
- Mortgages
- Car loans
- Credit cards
- Personal loans
- Lines of credit
Some credit life insurance policies also include disability insurance coverage. If you become disabled and cannot work, the credit disability insurance will cover your payments until the debt is paid off or you can work again, whichever comes first.
Who Is the Beneficiary of a Credit Life Policy?
Your lender is the beneficiary of a credit life policy. These policies reimburse your lender if you pass away before paying all their money back. Banks, credit unions and other lenders are typical beneficiaries of credit life insurance policies. Car dealerships might also offer credit life insurance on car loans — in that case, the dealership would be the beneficiary.
Credit life insurance does not pay your family members and other beneficiaries. Instead, these policies help ensure your loved ones don't "inherit" your unpaid debt.
Potential Benefits of Credit Life Insurance
Helps you leave a larger inheritance: If you die with an unpaid debt, the creditor can make a claim against your estate for repayment. Your estate is the total value of your assets at death, such as your savings, home and investments. Your estate will need to pay off your outstanding debts first. Your loved ones only receive what then remains. Since credit life insurance helps pay off your debt, there likely will be more money left for your beneficiaries. It can also help make sure they keep assets after you die, like using mortgage insurance to pay off your home when you pass away.
Can help protect your beneficiaries from creditors: If a family member co-signed for your loan, they are legally responsible for the debt when you pass away. Credit life insurance would help pay off the debt so your loved one wouldn't have to do so completely on their own.
If you're married and live in a community property state, you share assets and debts with your spouse. A creditor could go after bank accounts, real estate and other property you owned with your spouse to repay the debt. Credit life insurance could help protect your spouse. The community property states are Alaska, Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin.
Doesn't require a medical exam: Credit life insurance policies are usually guaranteed issue with no medical underwriting. In other words, you don't need to answer health questions or take a physical to buy a policy.
Potential Drawbacks of Credit Life Insurance
Won't pay any money to your beneficiaries: Credit life insurance only sends out a death benefit to your lender. These policies do not provide any extra money to your loved ones to cover your final expenses or replace your income. The credit life insurance coverage also ends after you pay off the debt.
Premiums can be more expensive than regular life insurance: Since credit life insurance doesn't require a medical exam, the coverage could be more costly than traditional life insurance. If you're in good health, you might pay less by buying your own life insurance policy.
Can add to the cost of your loan: Taking out credit insurance is an extra cost. You need to pay the premiums, either as an upfront lump sum, with ongoing premiums or by adding the cost to your loan balance. If you add the credit insurance premium to your loan balance, the lender might charge interest on the insurance cost.
Who Needs Credit Life Insurance?
Now that you understand the credit insurance definition and how it works, do you need it? You may need credit life insurance if you are taking out a loan and want to make sure that debt is covered if you die. It can make sense if you don't have any other life insurance and assets to help pay off the debt.
You might be more likely to need credit insurance if you have a family member or friend co-signing the loan. You might also need it if you're married and live in a community property state. In these areas, your spouse would inherit your unpaid debt. Finally, if you can't qualify for other types of life insurance because of pre-existing conditions, credit life insurance can make sense as it doesn't check your health for the application.
It's your choice whether to buy credit life insurance. The law says lenders cannot force you to buy this coverage. While lenders might like credit life insurance because it helps them get repaid after your death, they cannot deny your application because you refuse to buy coverage. Lenders also cannot give you better loan terms or increase your odds of qualifying because you agree to purchase credit life insurance.
How Much Does Credit Life Insurance Cost?
The cost of credit life insurance depends on how much you plan to borrow and the length of your loan. Generally, the more you borrow, the more expensive the credit life insurance policy, as it could pay off a larger debt. Premiums can also depend on the type of loan you take out and where you live.
The cost of credit life insurance doesn't depend on your health. These policies are guaranteed issue. Applicants pay the same premium, regardless of health. In exchange, these policies typically charge more than regular life insurance that does use medical underwriting.
The only way to know for certain how much credit life insurance will cost is to apply for a free quote from your lender while setting up your loan. You could then compare this cost against setting up a regular life insurance policy.
Things to Consider Before Buying Credit Life Insurance
Before buying a credit life insurance policy, ask yourself the following questions:
Could You Qualify for Your Own Life Insurance Policy?
If you're young and in reasonably good health, you likely could qualify for an individual life insurance policy that costs less than credit life insurance. However, if you have health issues and worry about qualifying for a regular life insurance policy, credit life insurance could be a better choice. These policies don't consider your health for setting the cost.
Could the Unpaid Debt Impact Others?
If you pass away without paying off your debt, would it impact others? This is a concern if someone else co-signed your loan or your spouse would take over the debt in a community property state. That said, if you're single and no one else would be responsible for paying off your debt, it might not be worth getting credit life insurance.
Do You Have Other Savings or Insurance to Help Pay Off the Debt?
If you have other savings and life insurance, would you feel comfortable using that money to cover any outstanding debt after you pass away? That way, you wouldn't have to pay for credit life insurance. But if you want to maintain these savings for your beneficiaries, credit life insurance could be worthwhile. Consider how much life insurance you might need to cover all your financial goals.
Do You Want Life Insurance Protection After Paying Off the Debt?
Credit life insurance ends after you pay off the debt. These policies don't provide long-lasting protection. If you want coverage beyond the length of your loan or even for the rest of your life, consider getting your own life insurance policy. If you only want life insurance to help pay off debt, credit life insurance could make more sense.
The Bottom Line
Be sure to consider all your possible options before signing up for a credit life insurance policy. A financial professional could help you compare credit life insurance against regular life insurance to find the right fit for your debt management strategy.
