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Credit life insurance is a type of insurance policy that exists solely to pay off an outstanding debt if you pass away. When you take out a large loan, such as a home or vehicle loan, your lender may offer you a credit life insurance policy that covers the value of the loan. In the event of your untimely death, this policy would then pay back the lender so that your loved ones are not left burdened with covering the payments on these large loans. This overview may help you decide if a credit life insurance policy is right for you.
What is credit life insurance?
First, credit life insurance is not life insurance, says Kevin Lynch, assistant professor of insurance at The American College in Bryn Mawr, PA. Credit life insurance and life insurance are two completely different types of coverage. Simply put, credit life insurance is an insurance policy taken out by the borrower for the benefit of the lender. “It can be a little confusing,” Lynch says. “Although they’re two very different products, they often accomplish very similar results.” Of course, it does not help that the names are similar. Credit life insurance is also completely different from permanent life insurance, which is designed to stay for the permanence of your life.
Adding to the confusion, “credit life” is also a marketing slogan used with standard life insurance policies, with which insurance 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.
What does credit life insurance cover?
Credit life insurance usually covers any remaining debt that a borrower has on a large loan. 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 if the borrower dies before paying off the loan. 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, credit life insurance is commonly offered with auto loans and home loans. For example, if you and your spouse owe a mortgage on your home, a credit life insurance policy could cover the remaining debt on that mortgage if one or both of you dies before the loan is paid off. This type of protection could be especially helpful if the remaining spouse relied on both incomes to cover the loan payments.
How much does credit life insurance cost?
While credit life insurance rates will depend on the loan amount, these types of insurance policies can cost more than traditional life insurance. There are multiple factors that impact how much a credit life insurance policy costs, including the type of credit, the type of policy and the loan amount.
“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 is 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 will not be asked to take a medical exam or disclose health details because what is being insured is the balance of the loan, not the life of the borrower, says Lynch.
Things to consider before buying credit life insurance
Since credit life insurance may cost more than regular life insurance and is intended to benefit the lender, there are a few things to take into consideration before buying it.
You may want to consider buying credit life insurance if:
- You want to pay for coverage that is declining as you pay down debt. This is a good choice as you will be paying less and less protection each month.
- You cannot buy life insurance through regular channels because of the medical exam. Credit life insurance will not require a medical exam.
- If you cannot qualify for enough life insurance to cover outstanding debts that you may leave behind. Credit life insurance will help you cover the debts so that your loved ones will not be responsible for them.
Credit life insurance and taxes
When it comes to taxes, there is 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.”
If you or your spouse were to pass away while holding a credit life insurance policy, the survivor would not be obligated to pay any taxes on the policy payout that covers the insured debt. For example, if a couple has a credit life policy on their home loan, and one of them passes away, the policy will remove their obligation to pay further on that loan. This process will not require them to pay any new taxes.
Alternatives to credit life insurance
Credit life insurance is not the only option for insuring your debts in the event of an untimely death. People who do not want to obtain credit life insurance might want to consider one of these alternatives:
Term life insurance
Term life insurance might be a good option for those who only want coverage for a limited timeframe and who have debt that must be paid off if something were to happen to them. Term life insurance is commonly offered in 5, 10 and 15 year terms, but may be offered for longer terms, such as 20 or 30 years. A term life insurance policy is generally less expensive than a credit life policy as well.
If you can cover your debt with money in an existing savings or investment account, your lender may not require credit life insurance. Ask your lender if this is an option for you. Keep in mind, however, that if you dip into that account for other purposes and the balance drops below the amount you need to cover that loan, your estate may still be responsible for the loan balance if you pass away.