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Credit Life Insurance

Credit life insurance pays a policyholder’s debts when the policyholder dies. Unlike term or universal life insurance, credit life insurance doesn’t pay out to the policyholder’s chosen beneficiaries. Instead, the value of a credit life insurance policy is paid out to the policyholder’s creditors. Here are the details:

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What’s covered?

When you sign on a personal loan, auto loan or mortgage, you can add a credit life insurance policy to the deal. The idea behind credit life insurance is to give you peace of mind that, when you die, your debts will die with you.

What’s the catch?

The catch is that most debts die with you anyway. Your kids won’t be on the hook for your car loan after you’ve shuffled off this mortal coil, so why buy credit life insurance?

There are a couple of reasons to consider credit life insurance. One is the protection it offers for shared debts. If you hold debt in common with another person (say you have a mortgage with your spouse, for example), then you do need to worry about settling the debt after you die. If you live in a common property state, your spouse could lose a chunk of your estate to your creditors. (As of this writing there are nine community property states: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin. Alaska allows couples to opt-in and make their property community property.) But a regular life insurance policy could help your spouse pay debts, too. You don’t necessarily need special credit life insurance.

Another reason that credit life insurance appeals to some is that it’s “guaranteed issue” life insurance. That means you’re eligible for coverage simply by virtue of being a borrower. You won’t need to undergo a medical exam to get credit life insurance. So if you’re certain that health problems have rendered you ineligible for regular life insurance, credit life insurance might be a good alternative.

Find out now: How much life insurance do I need?

Who benefits from credit life insurance?

It bears repeating: credit life insurance doesn’t directly benefit your spouse or heirs. Instead, the policies pay out to the your creditors. If you’re worried that your spouse will inherit an unmanageable debt burden upon your death, credit life insurance might set your mind at ease that your mortgage lender won’t kick your spouse out of the family home. On the other hand, with a regular life insurance policy you could make your spouse the beneficiary and leave it up to him or her to pay off the mortgage over time.

Is it worth it?

The general wisdom is that credit life insurance isn’t an ideal form of life insurance. Since most debts can’t be inherited anyway, credit life insurance isn’t all that necessary. And if you do have debts you share with other people, you could always use a term or universal life insurance policy to provide your beneficiaries with enough funds to pay off shared debt. You’ll get more coverage – for less money – with term life insurance than you would with credit life insurance.

One big downside to credit life insurance as opposed to regular life insurance is that the value of a credit life insurance policy decreases over time. Say you owe $200,000 on a mortgage you co-signed with your spouse. You decide to buy a $200,000 life insurance policy. If you buy a credit life insurance policy, the value of your policy will decrease from $200,000 as you pay down the mortgage, but you’ll keep paying the same premiums. That’s because you’re only insured for the amount you owe. But with term life insurance, you keep paying premiums and your policy value stays at $200,000, even if you completely pay off the mortgage. That’s better for your spouse and more value for your money.

The Hard Sell

It’s not unheard of for consumers to get talked into paying for credit insurance without realizing it. Occasionally, lenders will roll the cost of credit insurance into a loan agreement without disclosing the charges – or making it clear to the borrower that they are optional. This is illegal, and the Federal Trade Commission has issued a consumer warning about it.

It’s always a good idea to review a loan agreement before you sign it. If you see charges for credit life insurance, credit insurance, credit unemployment insurance or credit disability insurance, talk to the lender. These should be voluntary, so if you want them removed, speak up!

A lender can’t deny you a home loan or a personal loan just because you don’t opt for credit insurance. (Private Mortgage Insurance, which lenders charge on home purchases with a down payment of less than 20%, is a different matter.) If a lender tells you that your loan won’t go through unless you agree to buy credit life insurance, it’s a good idea to move on and find another lender.

If you decide to buy credit life insurance, be sure to ask whether the premiums will be financed as part of the loan or paid separately. If they’re financed, you’ll pay interest on them. More interest means more of your hard-earned money going to the lender, so you might want to fight for your right to pay the monthly premium separately.

Bottom line

It’s a great idea to think about how your heirs will fare financially in the event of your death, and to protect anyone who co-signed a loan, credit card or mortgage with you. In most cases, though, credit life insurance isn’t the best way.

Photo credit: flickr

Amelia Josephson Amelia Josephson is a staff writer covering financial literacy topics at SmartAsset. She holds degrees from Columbia and Oxford. Originally from Alaska, Amelia now calls Brooklyn home.

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