Creditor Life Insurance

You may be offered credit life insurance when you take out certain loans, such as a mortgage or car loan. While it may look like any other life insurance policy at a first glance, credit life insurance has some unique features. Here's what you should know about it and how it works before you buy a policy.

What Is Credit Life Insurance? - Credit life insurance is life insurance designed to pay off specific debt in the event of death, unemployment, illness or another event that may inhibit your ability to pay. When you take out a loan, the lender may offer you a credit life insurance policy. This policy is issued through an insurance company that the lender partners with.

The initial face value amount of the policy is equal to your loan amount. The policy's face value decreases over time as you pay down the loan balance. Premiums for credit life insurance are typically rolled into your monthly loan payments, and coverage begins when the loan is originated. If you die before the loan is repaid in full, your credit life insurance policy would cover the remainder of the loan, with policy proceeds paid directly to the lender to satisfy your remaining balance. 

Credit life insurance is different in many ways from a traditional term or permanent life insurance policy. With those, you choose the amount of coverage, rather than having coverage determined for you by a loan balance. The face value, or death benefit amount, typically remains the same for the life of the policy.

Traditional life insurance proceeds are paid to the beneficiary or beneficiaries named in the policy to use as they see fit, rather than being paid out to the lender exclusively for paying off your loan.

Benefits of Credit Life Insurance - The chief advantage of having credit life insurance in place is reassurance. If you were to die leaving a large loan balance behind, your policy would be there to pay it off. That means your loved ones aren't left with the responsibility of satisfying the debt. If you're married with young children, for example, credit life insurance could pay off your mortgage and allow your family to remain in the home.

Credit life insurance is often an affordable option to cover larger debts, such as a mortgage or car loan. The policy only covers the length of a debt, and once the loan is paid off, then the policy ends. It's a simple and affordable policy that's easy to purchase.

Unlike traditional life insurance coverage, credit life insurance doesn't require you to pass a medical exam to qualify. Your lender may offer this optional coverage, and you get to decide if you'd like to buy it. The premiums for credit life insurance can vary, based on the type of loan and the loan amount.

Your policy may include supplemental coverage for events other than death. For example, you may be covered against disability. If you're hurt or ill and can't work temporarily, your policy could make a limited number of monthly payments to your loan so you don't fall behind. That can help if you don't have emergency savings or a separate disability policy in place and you're worried about losing your car or home for nonpayment.

Credit life insurance can also extend similar coverage if you become unemployed through no fault of your own. And some policies may offer protection for collateral such as the car or home you're buying in the event that it's destroyed before the loan is paid off.

Downsides to Credit Life Insurance - Purchasing credit life insurance also has a few potential flaws. For example, having the lender as the beneficiary rather than a loved one of your choosing means there's no flexibility with these policies. If you die, your coverage can only pay off the specific debt it's underwritten to cover.

While credit life insurance could help pay off a specific loan, your loved ones couldn't use the coverage to address any other debts you leave behind.

A single-premium credit life insurance policy rolled into the cost of your loan and paid monthly can make premiums easier to manage. But you'll pay interest on the premiums over the life of the loan, which automatically increases the cost of coverage. Your premiums stay the same for the entire loan term, so you're basically paying for less coverage as time goes on.

Another potential snag may lie in the fine print. For instance, your policy may include disability or unemployment coverage but only pay out for a limited period of time. If you remain disabled or unemployed beyond the time frame established by the policy, keeping up with your loan payments could prove difficult. Or you may need to be employed for a set time period or earn a certain amount before disability coverage kicks in.

While your insurer may not require a health exam to get covered for credit life insurance, it may deny the policy's claim when you die if it turns out you had a pre-existing health condition.

Should You Buy Credit Life Insurance? - The answer depends largely on your needs and whether you have (or could qualify for) other life insurance policies that could help with paying off debt or other expenses when you die. A traditional life insurance policy gives you more flexibility but may be more difficult to obtain.

Your age and financial situation can help determine the true value of credit life insurance for you. Keep in mind that credit life insurance policies may have an age cutoff for coverage. Someone in their 60s buying a vacation home, for example, may not be eligible for this type of life insurance because the insurance company may consider age too much of a risk factor.

Your health is something else to consider before buying credit life insurance. The minimal underwriting required for credit life insurance may mean it's easier to get covered for credit life insurance versus a regular life insurance policy if you have a pre-existing condition. But again, keep in mind that pre-existing conditions may count against you when it's time for the policy to pay out.

Review Your Credit Life Insurance Alternatives Carefully - It's possible that a traditional life insurance policy may better suit your needs. Consider the costs involved in buying credit life insurance and compare that with what you might pay for a term or permanent life insurance policy instead.

Generally, the younger and healthier you are when you purchase a term life insurance policy, the lower your premiums are likely to be.

Purchasing a permanent (or whole) life insurance policy typically means paying higher premiums than other life insurance options, including credit life insurance. But it offers the ability to build cash value. This cash value can grow with interest , and you can borrow against it if needed. Credit life insurance doesn't have this feature.

Check to see what type of life insurance coverage you may already have in place. For example, your employer might include a small term life policy in your benefits package. If you don't need life insurance beyond the amount you already have in place to pay off debts, then buying a credit life policy could be a waste of money.

Consider getting advice from an insurance expert before you buy if you're still undecided because "you might find several products that better fit your situation in life.