Credit insurance offers coverage that pays off or makes payments on a specific debt such as a mortgage or loan or specific credit card balance in the event of the policyholder's death or disability or involuntary job loss. In other words, the contract insures the debtor for the benefit of a specific creditor. The benefits are typically paid directly to the lender not the holder of the policy. The principal types of credit insurance include:
Credit life insurance pays off all or some of a loan or mortgage if you die. Although most credit life policies pay off the whole outstanding balance, some policies may have cap limits. Credit life or mortgage-protection life insurance offer decreasing-benefit policies, which means they pay off only what remains of the loan.
Mortgage disability and credit disability insurance makes your mortgage or loan payments if you become ill or injured and can't work. Typically the payments are made for a limited period spelled out in the contract and there often is a waiting period before benefits can be claimed. If the insurance is for a credit card account, the payment is typically the monthly minimum.
Job loss or involuntary unemployment
Job loss or involuntary unemployment insurance pays your minimum loan or mortgage payment for a specified period of time if you lose your job. There may be a waiting period before benefits may be claimed. You must be laid off or fired from your job (unless misconduct was the cause for firing) to make a claim; you cannot make a claim if you quit. Self-employed people do not qualify for job loss credit insurance. This type of insurance may be offered with mortgages, credit cards, and other types of consumer loans.
Credit insurance may be offered at the point of purchase of an item that you are buying with an installment loan such as an automobile, furnishings, appliances, or electronics. In such cases the lender or the retailer representing a lender typically ask if you want credit insurance as part of drawing up the loan agreement. If you are applying directly to a lender for a mortgage or loan (such as an auto loan), you may be asked if you desire credit insurance as part of the loan proposal. Credit insurance offers on credit cards may come in the mail or in a marketing phone call after you receive a card.
No, not usually. In most cases, the purchase of credit insurance is optional. Lenders can not generally make your refusal to buy the credit insurance they offer a condition of the loan. But the lender may require that you protect the loan by some other means such as assigning part of your existing life or disability insurance.
The Federal Trade Commission and other consumer protection agencies note that one continuing problem in the field of credit insurance is that many consumers are under the impression that they must take the offered credit insurance to qualify for the loan. In a moment-of-sale setting, some retailers and lenders may pressure consumers to take the credit insurance or even suggest that it's necessary. The FTC notes that it is “against the law for a lender to deceptively include credit insurance (or other optional products) in your loan without your knowledge or permission.” That permission must be in writing.
To avoid potential pressure at the point of sale, it's wise to consider the question of credit insurance before you begin to shop for a loan or an item you plan to finance.
Don't confuse mortgage credit insurance, also known as mortgage-protection insurance, with Private Mortgage Insurance (PMI) which mortgage lenders require of homebuyers who make less than a 20% down payment. A lawful requirement, PMI protects the lender should the homebuyer default on the mortgage. As soon as the homeowner has accrued a 20% equity in the property, the mortgage lender by law must inform them of how to apply to drop the PMI.
On a cost per dollar of benefit basis, credit life insurance is more expensive than regular term life insurance. If you are younger and considering credit life insurance on a loan because you don't have adequate life insurance, then most financial planning specialists advise that you consider buying a term life insurance policy (or increasing one that you already own) that would offer greater protection to your family. Because the cost of credit life does not increase with age, it may offer a more cost-effective option for older adults who desire such protection.
Costs, limitations (such as waiting periods or medical supervision), and benefits can vary so widely among credit disability policies that it is difficult to make general statements about cost. That's one of the reasons that it is so important to compare policies if you are considering credit disability insurance. The same can be said of credit unemployment insurance.
One of the ways that insurance industry experts and consumer advocates judge the value of a particular insurance product is to look at the “loss ratio”—that ratio may be defined as how much of the premium dollars taken in does the insurance company pay out in benefits. For credit life and disability, the National Association of Insurance Commissioners, state regulators have established a standard of a 60% loss ratio for credit life and disability.
If you opt for credit insurance, compare products very carefully using the questions in the next section.
Only you can decide if you want credit insurance. Before you buy or choose a specific policy, the Federal Trade Commission, the nation's consumer protection agency, suggests that you ask the following questions.1
How much is the premium?
Will the premium be financed as part of the loan? If so, it will increase your loan amount and you'll pay additional interest, and more for points (if points are on your loan).
Can you pay monthly instead of financing the entire premium as part of your loan?
How much lower would your monthly loan payment be without the credit insurance?
Will the insurance cover the full length of your loan and the full loan amount?
What are the limits and exclusions on payment of benefits — that is, spell out exactly what's covered and what's not.
Is there a waiting period before the coverage becomes effective?
If you have a co-borrower, what coverage does he or she have and at what cost?
Can you cancel the insurance? If so, what kind of refund is available?
1 From "Credit Insurance: Is It for You?" a consumer alert from the Federal Trade Commission