When you take out a loan, you assume some risk, especially if you borrow a large sum of money. Protecting others from having to pay your obligations after you die is a natural concern. Debts are rarely inherited, therefore your loved ones are unlikely to be liable for your loan.
In rare cases, however, your debt may have a negative influence on those you leave behind. Credit life insurance helps to mitigate these risks by compensating the lender if you die before paying off the loan. However, this form of insurance is not always essential. Before purchasing a policy, evaluate the prices and look into alternatives such as term life insurance, which often provides the same level of protection at a cheaper cost.
What is credit life insurance?
If you die before repaying your loan, credit life insurance will pay it off. The policy’s face value is proportional to the loan amount; as you pay off the debt, the coverage amount lowers. If you die before repaying the loan, the insurer pays the remaining balance.
Credit life insurance protects the lender more than it benefits the borrower. Your premiums remain constant for the duration of the policy, regardless of how little the loan becomes. Lenders are usually always the beneficiaries of credit life insurance plans, which means that if you die, the payoff goes directly to them rather than your heirs.
Types of credit insurance
Credit life insurance is a sort of credit insurance that pays off when you die. Other types of credit insurance provide loan repayment in less extreme conditions, such as involuntary unemployment, incapacity, or personal property destruction.
What does credit life insurance cover?
Credit life insurance can cover a variety of loans, including mortgages, auto loans, and bank loans. In general, the amount of insurance cannot exceed the amount owed on the loan.
Your state may establish maximum coverage restrictions for this form of insurance. Credit life insurance plans for mortgages in New York are normally limited to $220,000, according to the New York State Department of Financial Services. As a result, if your mortgage is worth $440,000, your credit life insurance policy will only cover half of it.
Banks or lenders typically sell credit life insurance when you take out a loan. However, you are not compelled to obtain coverage if you do not want it. In truth, lenders are often unable to reject a loan application based on the borrower’s refusal to acquire optional credit insurance. It is also prohibited for lenders to put credit life insurance in your loan agreement without your knowledge or approval.
Alternatives to credit life insurance
When looking for loan insurance, credit life isn’t the only alternative. Before purchasing a policy, consider the alternatives listed below.
Credit life insurance vs. term life insurance
You can cover your loans with a conventional term life insurance policy. This sort of coverage is often less expensive and more versatile than credit life insurance. A term life death benefit is typically fixed for the duration of the policy and pays out regardless of the amount owed on your loan. Unless your will or trust states otherwise, or the lender is specified as the beneficiary, it is your recipient’s responsibility to repay the loan.
In addition, you can select a life insurance beneficiary for your term policy. This implies that the money goes to the individuals or entities you pick, not the lender, regardless of how much of the loan you have paid off, and they can use it for whatever purpose they like.
Existing life insurance policies
Instead of purchasing additional coverage, you can use your existing term or permanent life insurance policy to pay a loan. However, be sure you’re comfortable using some cash from your existing policy to cover the loan, especially if you purchased the policy to cover specified expenses.
Traditional Savings Account
Existing savings or investment accounts can provide an excellent financial safety net. If the contents in your savings account are sufficient to pay any outstanding debts after your death, you may not require insurance.
Is credit life insurance right for you?
If you’re solely concerned about debt inheritance, you probably don’t need credit life insurance. That’s because your debt rarely passes to your heirs after your death. Instead, your estate pays off your debts with your assets. If there isn’t enough money to fulfill your obligation, it usually stays unpaid, and family members aren’t obligated to pay it.
However, an outstanding loan might often have a detrimental impact on your estate plan. Life insurance can be useful in the following situations.
- You don’t want your estate to pay your debts. When you die, the asset for which you borrowed money—such as a car or a house—may be auctioned to repay the lender. This can diminish the amount left for your heirs. Loan insurance will cover any outstanding payments if you die, keeping the debt out of your estate.
- You wish to protect the co-signers. When you co-sign a loan, you assume equal responsibility for the debt. If you die, credit life insurance will pay off any outstanding debts, relieving any surviving responsible parties of the burden.
- You reside in a community property state and wish to safeguard your spouse. In states with community property rules, your assets and debts are often transferred to your spouse. A credit life insurance policy will pay off the loan so your spouse does not have to. States with community property laws include Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin.
How much does credit life insurance cost?
Credit life insurance premiums vary depending on the size and kind of the loan. The costs may be greater than for other life insurance products due of the following important factors:
- Coverage is usually guaranteed, regardless of your condition. As with most guaranteed issue life insurance policies, insurers typically charge higher rates when they do not know your medical history because the risk of insuring you rises. Not every credit life insurance policy is guaranteed. Your age, health, and employment position may impact your eligibility.
- Lenders may wrap insurance premiums into loan payments. This may seem like a smart idea, but it can wind up costing you more. You are essentially borrowing money to pay your insurance premiums, which raises the interest you pay.
- The premiums remain constant, but the death benefit declines with time. This implies you’ll pay a larger premium up front, but the same price for less coverage year after year.
Can you cancel credit life insurance?
If you need to cancel your credit life insurance policy early, you may be allowed to do so. You may also be entitled for a prorated refund on any unused premiums. For example, suppose you paid an annual premium; if you cancel halfway through the policy year, you will be refunded for six months of charges.
However, cancellation conditions differ per lender. The opportunity to cancel your insurance can be handy if you have paid off the majority of your debt and do not want to continue paying the same cost for less coverage.
Before you purchase a policy, inquire about the ability to discontinue coverage early and, if applicable, the sort of refund policy.
