If you’ve recently applied for a loan and been offered credit life insurance, you may be confused as to what this type of coverage does and whether you need it. Unfortunately, lenders aren’t always up front about your obligation to purchase credit life insurance — and some have been known to include it in loan payments without fully disclosing its existence, which is against the law.
Exactly what is credit life insurance, and is it worth purchasing when taking out a sizable loan? This depends on a few variables such as where you’re located and who is signing the paperwork with you.
What Is Credit Life Insurance?
Lenders know that every time they issue a loan, there’s a chance of the borrower not paying the funds back. Most often this is because the borrower falls on hard financial times and is unable to continue making payments. While much less likely, another possibility is that the person who took out the loan passes away unexpectedly before the full amount has been repaid.
To protect themselves against this circumstance, lenders turn to credit life insurance. This is one of four main types of credit insurance, but the only one specifically designed to pay off the loan balance in the event of the borrower’s death. Credit life insurance is typically taken with a death benefit that equals the full loan balance amount. This benefit can then be collected by the lender if you pass away.
How Credit Life Insurance Works
Since they’re similar in name, many people equate credit life insurance to traditional life insurance. While both types of policies share some similarities, credit life insurance works quite differently from a whole or term life policy you might take out yourself.
With credit life insurance, the borrower is responsible for covering the insurance premium, which can be paid in cash or financed as part of the loan. In the latter scenario, the borrower will also have to pay interest on the premium amount. However, unlike standard life insurance, the lender is the sole beneficiary of the policy and will receive the funds directly if you die. Your surviving heirs won’t ever see a dime of the payout.
Who is Credit Life Good For?
According to U.S. law, lenders are forbidden from requiring borrowers to purchase credit life insurance or including it in the loan terms without informing you. To skirt these requirements, some lenders may intentionally use confusing language to make credit life insurance seem like more than it is.
In reality, credit life insurance is only good for the lender most of the time. The CFPB clearly states that your family members can rarely be held responsible for your debts if you pass away. There are a few exceptions that vary by local law; for example, in nine states, your surviving spouse may be on the hook for any outstanding loan balances in your name. Otherwise, if there aren’t enough assets in your estate to repay your debts, the lender will be out of luck.
All things considered, credit life insurance can be a good idea in a couple different scenarios. If someone is cosigning a loan with you, credit life insurance will make sure they don’t bear the responsibility of repaying the loan in your absence. It’s also beneficial if you do happen to live in a community property state that considers debt the responsibility of the surviving spouse. These states are Arizona, California, Idaho, Louisiana, New Mexico, Nevada, Texas, Washington and Wisconsin.
- Covers loan cosigners: If someone cosigns a loan with you, a credit life insurance policy ensures they won’t have to take over payments if you pass away.
- Can protect surviving spouses from financial responsibility: In the nine states that hold surviving spouses responsible for outstanding debts, credit life insurance is a good source of protection.
- No medical exam required: Credit life insurance rarely requires a medical exam.
- May provide additional benefits: Some credit life insurance policies also pay benefits if you become terminally ill or seriously disabled.
- Raises monthly payments: If credit life insurance premiums are rolled into your loan payments, the amount will go up.
- May only be used to repay loan: Unlike a standard life insurance policy, your surviving beneficiaries can’t access credit life insurance funds to pay other expenses.
- Can be more expensive than life insurance: The CFPB warns that credit life insurance premiums are sometimes more expensive than standard life insurance.
- Subject to waiting periods: Some credit life insurance policies don’t take effect until after a waiting period has passed.
How To Get Credit Life Insurance
If a lender wants you to get credit life insurance before signing loan paperwork, they’ll typically already have a provider in mind. But remember that you’re never required to use the insurer your lender works with. Plenty of credit life insurance companies will be more than willing to write you a policy. Don’t be afraid to shop around for quotes and see if you can find something more affordable than the bank’s suggestion.
Of course, there’s also the alternative of simply purchasing a standard life insurance policy with a higher limit that takes all your various debts and financial responsibilities into consideration. This is a more flexible option as it lets your surviving beneficiaries decide where to put the funds based on their needs at the time of your death. It also typically costs less than taking out a separate credit life insurance policy.
Like most life insurance benefits, credit life insurance payouts are not considered taxable income.
Credit life insurance isn’t always necessary, but it can be a good idea if you have a loan cosigner or if you live in a state where your spouse can be held responsible for your debts if you die.
Some credit life insurance companies may have a maximum age limit. However, these limits are determined by each insurer. You should ask each provider about age limits if you’re concerned about being denied coverage.
The lender is the beneficiary of a credit life insurance policy. In the event that you pass away, the total benefit amount will be paid directly to the financial institution.
Mortgage protection insurance is a specific type of credit life insurance that may be taken out when you purchase a home. The policy will pay your outstanding mortgage balance if you pass away before you finish paying off your home. This allows your family to keep the home at its current value.