When you die, your loved ones are protected not only from losing your income but also from having to take on your outstanding debts. An insurance policy tied to a particular debt, such as a mortgage or business loan, is called credit life insurance.
In this case, the death benefit covers only the loan, with the lender being the beneficiary rather than your family or another individual of your choosing. Typically, there may be better options than a credit life insurance policy if you qualify for a more traditional life insurance policy.
What is Credit Life Insurance?
A credit life insurance policy will pay the remaining balance of your outstanding debt should you die before it is paid off. It is usually taken out for a mortgage, auto, or business loan. If you die, the death benefit is paid directly to the lender.
You may have heard this referred to as mortgage protection insurance. The benefit to credit life is you are always going to be approved. As you make the payments, the death benefit will reduce along with your loan most of the time.
How Does Credit Life Insurance Work?
Installment loans and lines of credit, like home or business loans, often include the option to buy credit life insurance. Premiums for credit life policies are generally incorporated into your loan payments since they are typically purchased alongside a loan.
If you have a health condition that might disqualify you from buying traditional life insurance, credit life coverage won’t require you to undergo the underwriting process. This is beneficial because you have guaranteed approval.
The loan or credit line amount will impact the cost of life insurance. Most lenders will give you the option to purchase credit life insurance when you apply for a loan, and if you choose not to purchase a policy, that is okay, and the lender cannot deny your application because of it.
What Limitations Does Credit Life Insurance Have?
Credit life insurance does not pay a death benefit to your family but to the lender. Credit life insurance may cost you more money than a standard life insurance policy, especially if you tie the premiums into your loan and pay interest on it.
What Does Credit Life Insurance Cost?
A credit life insurance policy’s cost varies depending on the credit or loan balance, the type of credit, and the type of policy purchased. You will have to pay more for insurance if you need to cover a large credit balance. Generally, a credit life insurance policy costs more than a standard one.
For example, a term life insurance policy is usually cheaper than a credit life insurance policy. You can get credit life insurance regardless of your health status. As a result, insurance companies face more significant risks regarding credit life policies. Your health is generally considered when determining your term life insurance rate, so your rate will be lower if you are healthy.
Advantages and Disadvantages of Credit Life Insurance
As with any life insurance policy, credit life has advantages and disadvantages. It is critical to understand all of them when deciding what is most beneficial for you.
A significant advantage to credit life insurance is that it will pay a specific debt if you die. In comparison, a standard life insurance policy pays an individual beneficiary, and unfortunately, it cannot be guaranteed that your debts are paid.
Credit life insurance can be more affordable if you only need to cover a small loan rather than purchase a life insurance policy with a significant death benefit. All credit life insurance is also a guaranteed issue policy so that you will be approved regardless of your health.
Another advantage of credit life is if you have a co-signer on the loan, they will not be financially impacted if you die since the loan will be paid by the credit life insurance policy.
In most situations, a standard life insurance policy will be more beneficial than a credit life insurance policy. Most people have more than one loan as part of their overall debts, so having a credit life insurance policy on one loan can leave other debts outstanding.
Additionally, there is no flexibility regarding the payout of the death benefit. Your family will not receive the payout, so they will be left to pay for other debts and end-of-life and funeral expenses, which can be quite costly if the family has little to no savings built up.
Alternatives to Credit Life Insurance
While credit life insurance will always be available as an option for you and your family when you get a new loan, there are some alternatives to consider when looking at your whole financial plan.
Term Life Insurance
Term life insurance is an excellent alternative to credit life as it is an affordable option and can help pay off the outstanding debts you leave behind if you die. Term life insurance usually comes in lengths of 10, 20, or 30 years and will pay out a death benefit you choose when you purchase a policy to a beneficiary of your choosing.
Savings or Investment Account
You may not need credit life insurance if you can cover your debt with money in your savings or investment accounts. Consult your lender about this option. However, remember that if you use your savings or investment accounts for other purposes and the balance drops below the amount required to cover the loan, your estate may still be responsible for paying it off.
Who Should Consider Credit Life Insurance?
Consider purchasing credit life insurance if you want to make sure a specific loan gets paid upon your death, if you want to protect a co-signer, or if you live in a state with community property laws and debt may pass on to your family.
Credit life insurance may not be necessary when your only concern is your family having to pay your debts. When you die, your debt doesn’t usually pass to your family. Assets are used to settle your debts by your estate.