What is not allowed in credit life insurance

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 and can be very expensive. Before you buy a policy, consider the costs and explore alternatives like term life insurance, which typically offers the same type of protection for less.

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, theft or destruction of personal property, or leave of absence.

What does credit life insurance cover?

Credit life insurance can cover mortgages, auto loans, education loans, bank credit loans or other types of 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 credit life insurance policies. 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 insurance policy may only cover 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 can’t reject a loan application based on the borrower’s refusal to purchase optional credit insurance, according to the Federal Trade Commission. It’s also illegal for lenders to include credit insurance 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

Standard term life insurance can pay off your loans if you die, and it’s typically cheaper and more flexible than credit life insurance. The death benefit stays the same throughout the length of the policy and pays out regardless of the loan amount.

Also, you can choose a life insurance beneficiary for your term policy. This means your heirs — 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.

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Existing life insurance policies

Instead of buying more coverage, you can use an existing term or permanent life insurance policy to cover a loan. Keep in mind that lenders may want to see proof of coverage before proceeding. Also, 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 co-signers.

• 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 among states 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:

1. 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 impact your eligibility.

2. 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.

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 off most of your loan and don’t want to continue paying the high 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.

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