What is Credit Life Insurance and Do You Need It?
If you have a mortgage, personal loan or auto loan, you might have been offered credit life insurance from the lender.
Not to be confused with traditional life insurance, credit life insurance promises to repay all or a portion of a debt balance in the event you pass away.
But with many other insurance options available, is credit life insurance the best pick for the problem you want to solve? We will break it down for you here.
How Credit Life Insurance Works
As described above, credit life insurance is a life insurance policy tied to a specific debt.
It may be offered by a lender as an opportunity to have a large debt extinguished upon your death so as not to become an obligation for your family.
In some situations, particularly involving business loans, a lender may require credit life insurance to ensure repayment upon your death.
That will also offer you an opportunity to pass your business on to your heirs, debt-free.
In most cases, credit life insurance is tied to a single debt.
That being the case:
It’s possible to have multiple credit life insurance policies if you have several large debts.
A typical credit life insurance policy is a form of guaranteed issue, decreasing term life insurance.
Let’s say you have a 10-year loan for $50,000.
The credit life insurance policy will be issued for a term of 10 years, and an initial death benefit of $50,000.
But just as the loan balance declines during the term, so does the amount of the death benefit in the credit life insurance policy.
The decline may not match the paydown on the loan on a dollar-for-dollar basis, but it will approximate the payoff amount at any point in the term.
Clear your debt
The most basic advantage of credit life insurance is that it will eliminate a debt – perhaps a very large one – upon your death.
Your beneficiaries will not need to use proceeds from other life insurance policies you have to pay off the debt.
In that way, credit life insurance frees up your primary life insurance to provide for your beneficiaries’ survival.
As well, the elimination of the debt removes a monthly obligation from your family’s budget, lowering their cost of living.
May help retain major assets
There’s an important limitation here.
Generally speaking, an individual debt is not inherited by his or her heirs. Typically, a loan obligation will be canceled upon the death of the debtor.
However, if the loan is secured by property owned by one of your heirs, like your spouse, the debt will run with the property.
This will be the case with secured loans, such as mortgages and car loans.
A credit life insurance policy will pay off the debt upon your death and ensure that your co-owning heir will be able to retain the securing property.
Along the same line, credit life insurance can also pay off a debt that has been cosigned by another person.
Should you die before the loan is paid off, the obligation could become the responsibility of the cosigner.
But if you have a credit life insurance policy for the debt, it will be paid off upon your death, and not become the responsibility of your cosigner.
Credit life insurance also has the advantage of being guaranteed issue.
That means you’ll be approved for the coverage regardless of the condition of your health.
It's an excellent choice for someone who otherwise might not qualify for a typical life insurance policy but has large debts they’d like to have paid off when they die.
One of the major disadvantages of credit life insurance is cost.
Since it’s typically a guaranteed issue policy there is no medical underwriting involved. The insurance company is taking on greater risk for issuing this type of plan.
The premium on a credit life insurance policy is often several times higher than a comparable amount of ordinary term life insurance.
Premiums mixed in with monthly payments
Another disadvantage is when credit life insurance is offered by the lender.
(The lender is probably not in the insurance business but subcontracts the coverage out through a third-party provider.)
In such cases, the lender will often include the premium on the credit life insurance in the monthly payments on the debt.
That can make it more difficult to determine exactly what your premium is, or even your net monthly payment on the loan.
Beneficiaries are not chosen by you
An obvious disadvantage is that your beneficiaries will not receive any portion of the proceeds of a credit life insurance policy upon your death.
That means you will still need to maintain other life insurance to provide for the financial needs of your loved ones, in addition to credit life insurance.
Less worth it over time
Finally, even though the death benefit on a credit life insurance policy will decline over the term of the policy – consistent with the decrease in the outstanding balance of the loan it’s intended for – your annual premium will remain the same.
For example, if you have a $50,000 credit life insurance policy with an annual premium of $1,000, it will be the same in Year 8 – when the death benefit may be reduced to only $10,000 – as it was when you first took the policy.
Put another way, credit life insurance becomes progressively more expensive on an annual basis the longer the policy is in force.
Death benefit waiting period
This can be the single biggest disadvantage of all. One of the features common to guaranteed issue life insurance policies is a waiting period, during which no benefits will be paid.
This is part of the reason insurance companies will provide guaranteed issue life insurance policies.
The risk of ignoring health considerations is reduced considerably if no benefit will be paid during the early years the policy is in force.
A typical waiting period on a guaranteed issue life insurance policy is two years.
If you die within the first two years of the policy date, no death benefit will be paid, and the loan will remain outstanding.
In such cases, the insurance company typically refunds the premiums paid during the waiting period. But that might not make even a small dent in the debt you intend for the policy to pay off.
If you are purchasing credit life insurance, either directly from an insurance company or through the lender, be sure to ask about the existence of a waiting period.
It will make little sense to have credit life insurance that won’t pay the death benefit within the first two years of a five year loan – when the loan balance is at its highest.
Can You Cancel It?
One of the problems with credit life insurance:
You may not be aware you have it.
For example, let’s say you purchased a car and obtained financing from or through the dealer. The dealer may offer credit life insurance as an optional provision. But they may not exactly present it as optional.
There may be some subtle implication that approval of your loan is somehow contingent on having a credit life insurance policy in place.
If that’s the case, you may assume you can’t cancel the policy. But that’s not true.
According to the Federal Trade Commission, it’s against the law for a lender to deceptively include credit insurance in your loan without your knowledge or permission.
You’re not even legally required to purchase it from the lender.
While this is true of consumer loans, the situation may be different with business loans.
Because the lender is making a loan to a business entity, they may require credit life insurance as a condition of loan approval.
In that way, the lender will be paid even if the primary business owner(s) die(s).
From the lender’s standpoint, the death of a business owner often means the end of the business. That’s why they may require credit life insurance as a condition of the loan.
Buying from a third-party insurer
In still other cases, you may purchase credit life insurance independent of the lender.
For example, you may purchase credit life insurance to pay off your mortgage or a large auto loan upon your death.
Since you’ll have complete control over the policy, you’ll be able to cancel it at any time.
As well, nothing compels you to maintain a privately purchased credit life insurance policy.
For example, if you pay off an auto loan early, you may also choose to terminate the credit life insurance policy on the loan.
Other Types of Credit Insurance Policies
Credit life insurance is hardly the only type of credit related insurance policy available.
Credit disability insurance
This type of policy will make the payments on your loan if you become sick or injured, can’t work, and your income has been reduced or eliminated.
Involuntary unemployment insurance
Covers your loan payments if you lose your job through no fault of your own, as would be the case with a layoff. Benefits will not be payable if you quit or are fired for cause.
Credit property insurance
Provides coverage for personal property securing a loan if that property is destroyed by accidents or natural disasters or is stolen.
Credit life insurance is a very specific life insurance policy designed to pay off a particular debt.
This is usually available without health qualification, which means approval is virtually guaranteed.
This is term insurance, with a declining death benefit, designed to roughly match the loan balance outstanding during any point in the term.
In most cases, credit life insurance is not a requirement.
However, a lender may attempt to sell it to you with the implication that it is required for loan approval.
Except for business loans, this is almost never true.
You don’t need to take credit life insurance, and you don’t need to take it through the lender. You can purchase a policy on your own and cancel it anytime you like.
The reality is:
Credit life insurance is expensive when compared to traditional term life insurance.
If you have several debts you want paid off, it may be more cost-effective to purchase a single traditional term life insurance policy with a death benefit equal to the total amount of loans owed.
Not only will that be less expensive than dedicated credit life insurance, but you’ll be able to maintain the policy even after the debts are paid.