What’s Credit Life Insurance? Pros, Cons & Cost

Updated

Consumer magazines and life insurance review sites are generally pretty rough on credit life insurance. Some articles try to remain neutral, some are downright against people buying it, and some (usually written by insurance companies) will tell you that it’s the greatest thing since sliced bread.

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In this article, we’ll give you the facts about credit life insurance so that you can make your own mind up. We’ll talk about what credit life is, what it isn’t, who can buy it, who needs it and who doesn’t, how much it costs, and more. 

What Is Credit Life Insurance?

Credit life insurance pays off an insured person’s debt if they die or become disabled before paying it off. Unlike traditional life insurance that pays the death benefit to someone you name as the policy’s beneficiary, credit life insurance pays the death benefit to a lender.

Some opponents of credit life believe that because you don’t have a choice in who the policy’s beneficiary is, credit life insurance actually isn’t really life insurance. They believe that since the lender mandates that they’re the beneficiary and they receive the death benefit if you die while any portion of the loan is outstanding, it doesn’t qualify as a life insurance policy.

This is an interesting theory, but life insurance companies disagree. If the reason they have to pay out the face amount of your policy is that you died, life insurance companies don’t care who the beneficiary of your policy is—they consider it a life insurance contract. 

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What’s the Difference Between Traditional Life insurance and Credit Life Insurance?

As mentioned, the main difference between traditional life insurance and credit life insurance is that your lender is the beneficiary. You can’t choose a different beneficiary (like a child or spouse) for a credit life insurance policy. But there’s one other major difference: the payout amount.

A credit life insurance policy’s payout shrinks over time

If you take out a $200,000 traditional whole life insurance policy to cover a mortgage and you die five years later when the loan balance was $150,000, the policy’s beneficiary (who you choose) will receive the full $200,000 death benefit.

That’s not the case with a credit life insurance policy. If you die five years into your loan with a $150,000 balance, the life insurance company will only pay out $150,000 to the policy’s beneficiary (your lender). In other words, the death benefit will always be the same as the outstanding loan balance.

But your premiums stay the same

So as your balance drops, the amount you’re paying each month for the policy should drop, too, right?  Afraid not. Your premium will always remain the same, even though the risk to the insurance company has decreased. 

With a traditional life insurance policy, your premiums also always remain the same, but the face amount of the policy never decreases, except under certain circumstances.

What Does Credit Life Insurance Cover or Not Cover?

Credit life insurance covers many different types of loans, including auto loans, mortgages, education loans, bank credit loans, and a variety of others. Lenders often recommend it because you’re paying a monthly insurance premium to make sure they’re paid in full if you die before your loan balance is zero.

Like traditional insurance, credit life also covers any cause of death (except suicide in the first two years). There are some types of life insurance policies that only pay if you die as the result of an accident, but that’s not the case with credit life insurance.

In some cases, credit life insurance won’t pay off your entire loan balance. This is because some states have face amount limits on credit life insurance policies. 

For example, New York State has a limit on credit life policies of $220,000. This means that if you buy a credit life insurance policy in New York to pay off your mortgage if you die, and the mortgage amount is $500,000, your credit life policy would only pay $220,000 of your $500,000 mortgage balance. That leaves a shortage of $280,000 if you want to leave your home to your loved ones debt-free.

How Much Does Credit Life Insurance Typically Cost? 

Like any type of life insurance policy, credit life insurance premiums are primarily determined by your gender and age (your health history doesn’t impact credit life insurance rates). 

Your out-of-pocket cost for a credit life policy is typically higher than for traditional life insurance for two reasons:

1. Your premium is rolled into your loan payment. This isn’t always the case, but it does happen frequently. By law, lenders are supposed to tell you when they do this, but not all lenders follow the rules. 

So if your credit life insurance premium is rolled into your auto loan that carries a 4% interest rate, that means your premiums are 4% higher than they normally would be.

2. Coverage is guaranteed-issue. Insurers assume greater risk with credit life insurance policies than they do with most other policy types because they will insure whoever applies for this type of policy, regardless of any past or current health problems. But this also means it costs more.

(In rare occurrences, credit life insurance policies are NOT guaranteed, with eligibility being affected by health, age, and employment status.)

Example credit life insurance rates

Here are some sample rates for credit life insurance. You’ll see them side by side with some traditional term life insurance rates (we’ll discuss term insurance a bit later). These sample rates are for a $50,000 policy for a person in good health. 

Age

Credit life

Term life

30

$370

$78

40

$370

$92

50

$370

$163

60

$370

$321

How Does Credit Life Insurance Work?

A credit life insurance policy works much the same as a traditional policy does. Factors include:

  • The face amount of the policy
  • A policy owner
  • An insured
  • A beneficiary or beneficiaries

When you apply for the policy, you’re the insured person and the owner of the policy (not the lender). By being the policy owner, you have the power to cancel the policy, if the legal agreement with the lender allows it.

For example, let’s say you borrowed $25,000 to buy a car four years ago. You purchased a credit life insurance policy for your $25,000 debt, which has a $140 monthly premium. Now, your loan balance is down to $8,000, but your credit life insurance premium is still $140 per month. 

You may have enough money in savings that your family can pay off the debt if you die, and canceling the policy will save you $140 per month that you don’t need to spend. If you decide to buy credit life insurance, verify with the lender that you have the right to cancel the policy whenever you want to. 

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Pros and Cons of Credit Life Insurance 

Any kind of life insurance has its pros and cons. Whole life builds cash value, but its premiums are comparatively high. Term life insurance is much less expensive than other kinds of life insurance, but it has an expiration date. 

Credit life is no different. Here are the pros and cons:

Pros of credit life

  1. Guaranteed issue. For someone who has a serious pre-existing health condition that prevents them from being approved for a standard life insurance policy, credit life gives them the chance to protect their loved ones financially by not leaving a large debt behind if they died with a loan balance. Premiums are higher for credit life because of this, but to many people that have been repeatedly rejected when applying for life insurance, it’s worth the extra cost.
  2. Protects procrastinators. Most of us have good intentions, but most of us are procrastinators. We have every intention of buying that term insurance policy to pay off that car loan if we die, but somehow we just never get around to it. By accepting the lender’s offer to provide credit life insurance, a borrower is certain to prevent someone else from getting saddled with an obligation they can’t handle financially.

Cons of credit life

  1. Cost. Mortgage protection insurance and all credit life insurance policies are much more expensive than other types of insurance, like term insurance (see chart above). 
  2. Coverage amount. As mentioned, the policy might not cover the entire loan. Depending upon which state you live in, there may be a limit on the face amount of the policy, which can leave your survivors with a hefty loan balance if you die with a large amount of the debt unpaid.

Who Does (Or Doesn’t) Typically Need Credit Life Insurance?

Is credit life insurance right for you? If you’re healthy and can qualify for a standard term life insurance policy, you probably don’t need credit life insurance. You can buy less expensive term life insurance and it will serve the same purpose. 

If your main reason for buying credit life insurance is to protect your family from inheriting your debt, you probably don’t have to worry about it unless you live in a community property state (Arizona, California, Idaho, Louisiana, New Mexico, Texas, Washington, Wisconsin).

In these states, surviving spouses are responsible for their spouse’s debt. In the other 41 states, debt rarely passes to heirs, and if the survivors don’t have enough money to settle the debt, it will typically go unpaid and be written off by the lender.

If you are co-signing with someone for a loan, credit life insurance can make sense. As a co-signer, you’re equally responsible for the debt. Credit life ensures that anyone else listed on the debt with you won’t have to pay your portion of the balance if you die. It’s also wise to take out life insurance on your co-signers so you don’t get stuck with the loan balance if they die before you do.

Keep in mind that your beneficiary will receive the death benefit tax-free with a credit life insurance policy, just like any other kind of life insurance. 

Who Typically Buys Credit Life Insurance? 

One of the best features of credit life insurance is that you don’t need to answer any medical questions or have a physical examination when you apply for it. It’s a type of life insurance known as “guaranteed issue life insurance.” As the name implies, anyone who fills out the application is guaranteed to have a policy issued, regardless of their health history.

Let’s say that John has a history of uncontrolled high blood pressure and wants to buy life insurance to cover the cost of his new car. If he applies for a traditional life insurance policy, the chances of him getting issued a policy are pretty slim because he has a “pre-existing condition” that makes him an unacceptable risk to the insurance company. However, he would have no difficulty being issued a credit life insurance policy because it’s a “guaranteed issue” policy.

Why Do Some Life Insurance Policies Require a Medical Exam?

The vast majority of life insurance policies require a medical exam for two primary reasons:

  1. Life insurance companies want to keep premiums reasonably affordable for healthy individuals.
  2. Death claims are detrimental to the profitability of the life insurance company.

Both of these reasons are tied to “anti-selection,” meaning that there’s an increased risk that some people will buy life insurance policies when they believe their risk of dying is high because of poor health. This in turn leads life insurance companies to carefully select who they insure. Requiring a medical exam is one way they accomplish that.

Leaning Towards Credit Life If You’re Uninsurable?

If you’ve been turned down when applying for life insurance before, you don’t necessarily need to buy credit life insurance. An independent insurance agent represents many different life insurance companies; maybe one of them specializes in insuring people with your pre-existing condition. Don’t be pushed into buying credit life insurance buy a lender; they earn a commission by selling it to you.

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