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.
What Is Credit Life Insurance? (Explained)
Payment protection insurance (PPI), also known as credit insurance, credit protection insurance, or loan repayment insurance, is an insurance product that enables consumers to ensure repayment of credit if the borrower dies, becomes ill or disabled, loses a job, or faces other circumstances that may prevent them from earning income to service the debt. It is not to be confused with income protection insurance, which is not specific to a debt but covers any income. PPI was widely sold by banks and other credit providers as an add-on to the loan or overdraft product.
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 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 insurance
When shopping for loan insurance, credit life isn’t your only option. Consider the following alternatives before buying a policy.
1: 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.
2: 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.
3: 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.
Pros of Credit Life Insurance
There are a number of benefits that credit life insurance provides.
1: Peace of Mind for Loved Ones: Credit life insurance takes the responsibility of paying your mortgage or other debts off the shoulders of your loved ones when you pass away. That can be particularly important if you share a debt, like a home loan, with your spouse or someone else.
Joint borrowers would ordinarily become solely responsible for repaying loans or other debts if a co-borrower dies. A credit life insurance policy, however, would pay the debt for them.
2: Ease of Qualifying: Credit life insurance can also be easier to qualify for than traditional life insurance.
Many insurance companies require you to go undergo health screening to qualify for traditional life insurance. If you’re in poor health, you may face a high premium or be denied altogether.
While health may still be a consideration for credit life insurance, these policies typically have less stringent guidelines for approval.
Cons of Credit Life Insurance
Credit life insurance policies also come with downsides compared to other types of life insurance.
1: Limited Use: One of the biggest arguments against credit life insurance is that it doesn’t do anything that a traditional life insurance policy cannot. If you have a term life policy, for example, your spouse could just as easily use that to pay off your mortgage or other debts.
2: Loss of Value: The fact that a credit life insurance policy loses value is another potential downside.
If you take out a $250,000 mortgage and you owe $125,000 at your death, the policy would only pay enough to cancel out the loan. If you’ve paid off your mortgage entirely, your beneficiary receives nothing.
If you have a $125,000 mortgage and a $250,000 life insurance policy, by contrast, your beneficiary can pay off your mortgage and still have funds left over. They could use the difference to pay for burial expenses, set aside money for your children’s education, or simply cover day-to-day living expenses.
3: Cost: Cost is another consideration with credit life insurance. The amount you’ll pay for coverage depends on the type of credit that’s covered, the amount owed, and the type of policy. However, premiums for credit insurance are usually higher than traditional life insurance because of the higher degree of risk.
Note: The premiums you pay on your policy will likely remain the same, even once the payout benefit of your policy decreases. This is another reason credit insurance is more expensive than traditional life insurance.
How you pay the premiums is also important. If you have single premium coverage, for example, the premium may be built into your mortgage automatically. This can raise the total cost of buying a home because it increases your loan amount and results in paying more in interest over time.
A policy that features monthly premiums may be more cost-friendly but the size of the policy matters. And there may be limits on how much in loan value can be covered by a credit life policy.
If you have a larger mortgage, a credit insurance policy may fall short. Not only can purchasing a basic term life policy be more cost-effective, but it could also yield more rewards for your beneficiaries in the long-run.