Credit Life Insurance

Credit insurance is a controversial form of insurance that you purchase when you take out a loan. If you die, are disabled, or lose your job, your credit insurance policy makes payments on your debt until the loan is paid off or the policy ends. Credit insurance is linked with a specific loan and the cost of the policy is typically folded into your loan payments.

Although the various forms of credit insurance are big business, they are frequently criticized for being too expensive and too restrictive. Anyone thinking about getting credit insurance should compare credit insurance to other forms of life insurance, such as term life insurance, which can provide better coverage at a much cheaper premium.

The Types of Credit Insurance

Credit life insurance covers policyholders in the events of death, while credit disability insurance provides coverage for disabilities. Generally, you have to remain disabled for a certain number of days before the policy begins making payments, and when it does, those payments are either retroactive to the date of your disability or kick in after a waiting period of 14-30 days, depending on the terms of the policy.

Credit unemployment insurance makes your minimum monthly loan payments if you lose your job through a layoff or involuntary unemployment. Like credit disability insurance, you have to remain unemployed for a specific period of time and the benefit is either retroactive or kicks in after a waiting period.

Another type of policy, credit property insurance, is written for a purchase in which the collateral is not a motor vehicle, mobile home, or real estate. The policy pays to repair or replace a purchased item if it is lost, damaged, or stolen.

How Does it Work?

A borrower purchases credit insurance from the same company--a bank, finance company, credit union, auto dealer or furniture store--that makes the loan.

You can usually get credit insurance for many types of loans, including car loans, furniture purchases, student loans, credit cards, home equity loans, and mortgages.

You can pay for the policy by a single premium, which is typically folded into your loan amount, or a monthly premium for such open-ended loans as credit cards. Your outstanding balance and premium rate are used to determine the amount for your monthly payments.

Some companies offer a "free look" that gives you 30 days to decide if you want to keep the insurance after you've paid the premium. If you cancel, the premium should be repaid or credited to your loan balance.

In other cases, if you purchase credit insurance and change your mind, you can cancel and get a full refund within 10 days or a partial refund after 10 days. The time limit for a credit property insurance refund is generally 30 days.

Why Is Credit Life Insurance Sometimes Criticized?

Credit insurance is likely to cost more than other forms of life insurance, such as term life insurance, which can provide the same coverage. Even when premiums for term life insurance are at their highest--such as for customers who are age 60 or older--they are usually still cheaper than credit insurance.

Term life insurance makes more sense in other ways. People often take out term life insurance to ensure that major expenses, such as a child's college tuition, are covered if they die. In this case, you are assured the money is given to your beneficiaries and used to compensate for the loss of your income or to pay off outstanding financial obligations.

With credit insurance, your lender is the beneficiary. Your heirs only receive what is left over after the loan is paid off -- even though they are not be responsible for paying your debts unless their names are also on the loan account.

And credit insurance is often not a "good bet" for the consumer. A 2008 report by the Massachusetts Insurance Commissioner revealed how astounding credit insurance profits can be. The state examined loss ratios for various types of credit insurance. That's a measure of how much insurance companies make as opposed to how much they pay out in claims. In 2008, the credit life insurance loss ratio in Massachusetts was 20.75%. That means insurers paid out less than 21 cents for every $1 they made in credit life premiums.

By comparison, the loss ratio for group life insurance was 90 percent; meaning about 90 cents was paid out for every dollar paid in life insurance premiums. Group accident and health insurance paid 25 cents for every dollar in premiums, according to Consumers Union.

Credit Insurance Coverage Limited

There are other restrictions to credit insurance that buyers should be aware of, including:

  • If you file a claim within the first six months for a health condition you were treated for any time during the six months prior to getting your loan, you can be denied for a pre-existing condition
  • Your disability insurance covers your ability to perform your regular occupation only during the first 12 months. After that, for benefits to continue, you have to show you are unable to perform any occupation for which you are suited
  • Credit disability insurance may run out before the loan is paid off and may not cover balloon payments due at the end of a loan term
  • Insurance on a credit card only pays the minimum monthly payment, not the entire balance

Important Steps to Take

Before buying credit insurance, you should:

  • Compare the price of credit insurance to term life insurance or disability insurance
  • Compare the loan price with and without the insurance premium added in. You may have other assets, such as savings, which may cover your payments in the event that you lose your job or become disabled
  • Find out if the policy covers the full term and the entire balance
  • Find out if your homeowners or renters insurance provides the same coverage as credit property insurance
  • Ask what the waiting period is for disability or unemployment benefits to kick in. Do you have the assets to hold out that long?
  • Ask if the company or lender can cancel the policy and, if so, for what reasons
  • Ask if the policy terms can be changed without your consent

Because credit life insurance is tied to the financial institution making your loan, you might want to shop around to find the best terms for both your loan and your credit insurance. It also makes sense to compare credit life insurance with term life insurance.

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