Credit life insurance pays a policyholder’s debts when the policyholder dies. Unlike term or universal life insurance, it doesn’t pay out to the policyholder’s chosen beneficiaries. Instead, the policyholder’s creditors receive the value of a credit life insurance policy. If you’re wondering how this works, you’ve come to the right place.
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How Does Credit Life Insurance Work?
Let’s say you sign on a personal loan, auto loan or a mortgage. Getting credit life insurance is as simple as adding a policy to the loan deal. The idea behind this insurance is to give you peace of mind knowing that when you die, your debts will die with you.
Why Buy Credit Life Insurance?
Sure, credit life insurance will ensure your debts definitely die with you. However, 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 this kind of coverage. For one, it provides protection for shared debts. If you hold debt in common with another person (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.
Credit life insurance also appeals to some for its characteristic as “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 this kind of policy. So it provides a good alternative if health problems have rendered you ineligible for regular life insurance.
Who Benefits from Credit Life Insurance?
It bears repeating that 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 you’re carrying an unmanageable debt burden, credit life insurance could set your mind at ease. That way you know your spouse won’t inherit that debt or face eviction from your family home.
You could just make your spouse the beneficiary with a regular life insurance policy. This would place responsibility on him or her to pay off the mortgage (and/or other debts) over time. But if your life insurance policy won’t cover enough of your debt, credit life insurance could help.
Is Credit Life Insurance Worth It?
General wisdom states that credit life insurance isn’t an ideal form of life insurance. It isn’t really all that necessary since most debts can’t be inherited anyway. 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. However, you 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
Sometimes consumers can get talked into paying for credit insurance without realizing it. Occasionally, lenders roll the cost of the policy into a loan agreement without disclosing the charges or making it clear to the borrower that they are optional. This practice 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!
Plus, 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 says that your loan won’t go through unless you agree to buy credit life insurance, you might want to find a different lender.
If you decide to buy credit life insurance, be sure to ask whether the premiums are paid separately or financed into the loan. If they’re financed, you’ll pay interest on them. More interest means more of your hard-earned money goes to the lender, so you might want to fight for your right to pay the monthly premium separately.
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 to do so. It can be a handy tool, but other life insurance policies can achieve the same goals and more.
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