Life insurance for a borrower
When you hear about credit life insurance, it’s easy to confuse it with a standard life insurance policy. But consumers need to understand that credit life insurance, which is designed to pay off the balance of a loan in the event of death, isn’t life insurance, says Kevin Lynch, assistant professor of insurance at The American College in Bryn Mawr, Pa.
“It can be a little confusing,” Lynch says. “Although they’re two very different products, they often accomplish very similar results.” Of course, it doesn’t help that the names are similar. But here are five things you need to know about credit life insurance.
Credit life offered on auto, home loans
Simply put, credit life insurance is an insurance policy taken out by the borrower for the benefit of the lender. In a typical policy, the borrower will pay a premium — often rolled into their monthly loan payment — that allows the lender to be paid in full in the event the borrower dies before the loan is paid off. Title to the underlying asset is then transferred free and clear to the borrower’s estate and ultimately, to the beneficiaries of that estate. According to Lynch, it’s commonly offered with auto loans and home loans by the lender at the time of purchase.
Adding to the confusion, “credit life” is also a marketing slogan used with standard life insurance policies, with which agents suggest that regular life insurance is a way to pay off the mortgage. According to Tim Gaspar, CEO of Gaspar Insurance in Encino, Calif., that slogan, which has no bearing on the nature of the policy, usually means the consumer will end up paying more. “If they’re in the market for life insurance and they hear that term, they should look elsewhere,” Gaspar says.
Credit life is costlier coverage
While the price of a policy will depend on the loan amount, credit life insurance policies can cost more than traditional life insurance.
“It’s generally a little more with credit life insurance because there’s a greater risk associated with the product and that makes for higher premiums,” Lynch says.
That higher risk comes into play because credit life insurance is what’s known as a guaranteed issue product, meaning that eligibility is based solely on your status as a borrower. Unlike most life insurance policies, the applicant won’t be asked to take a medical exam or disclose health details because what’s being insured is the balance of the loan, not the life of the borrower, says Lynch.
Should you buy credit life?
If credit life insurance costs more than regular life insurance and is intended to benefit the lender, why would someone buy it?
That’s a good question, says Robert Hampton, an accountant in Fort Worth, Texas, who calls credit life insurance a “sucker’s bet.”
“You are paying for coverage that is declining as you pay down the debt, so you are paying for less and less protection each month,” Hampton says.
“If you’re not insurable, (meaning) you’re not able to buy life insurance through regular channels, it would be an option,” Hampton says. Credit life won’t require a medical exam, he says.
Some lenders require credit life
In some cases, a lender may require a borrower to take out a credit life insurance policy. According to Lynch, that’s generally the case with mortgage loans, but only in instances where the buyer doesn’t have a down payment of 20 percent of the home’s cost. When that happens, you might have to buy credit life at the lender’s insistence to get the loan.
But there’s a silver lining. Over time, a borrower will increase his or her equity position in the house and when it crosses the 20 percent threshold, the borrower can ask his or her lender to cancel the policy. Lynch says it’s a good idea to find appropriate life insurance coverage so that your loved ones will be able to make the mortgage payments if something happens to you.
Credit life sidesteps tax issues
With standard life insurance policies, coverage exclusions can be wide-ranging and vary a great deal state by state. But because credit life insurance is focused solely on the asset and not the person, exclusions don’t generally come into play, says Lynch.
However, Gaspar says one exception to that rule may be triggered by a suicide within two years of initiating the policy.
As for taxes, there’s little for the consumer to worry about with credit life insurance, says CPA Ryan S. Himmel, founder of BIDaWIZ, an online service in New York that matches consumers with financial professionals.
“Since the proceeds of the insurance policy go directly toward paying off the debt,” Himmel says, “and the insurance provider is essentially the beneficiary of the policy, not the family members, there wouldn’t be any implications to estate or inheritance tax.”
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