Credit Life Insurance

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What is credit life insurance? Credit life insurance is an insurance policy specifically designed to pay off a loan in the case of an untimely death. In the modern era of credit and debt-driven life, credit life insurance is one way of protecting your loved ones from financial struggles in the face of your loss.

What is credit life insurance?

First, credit life insurance isn’t 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 doesn’t help that the names are similar.

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.

How does credit life insurance work?

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. For example, if you and your spouse own a home and owe on the mortgage for it when one of you dies, then your credit life insurance will cover the remaining debt on that mortgage.

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. According to Protective, “There are three factors that typically determine the cost of a credit insurance policy: the loan amount, the type of credit, and the type of policy.”

“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 insurance?

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.

If you can qualify for a standard life insurance policy that will take care of financial needs in case of your demise, then credit life insurance may not be the best choice for you. However, if you cannot qualify for enough life insurance to cover debts that you may leave behind, then credit life insurance can be an excellent choice.

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 insurance and taxes

When it comes to 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.”

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.

Frequently asked questions

Does credit life insurance require a medical exam?

No, as credit life insurance is covering a loan instead of a person, medical exams are not required.

Do you owe taxes when your credit life insurance pays off your debt?

In most situations, you will not owe taxes when your credit life insurance policy goes into effect to cover your loan.

Do exclusions apply to credit life insurance?

Rarely. Since the policy is covering a loan instead of an individual, exclusions are far less common than with traditional life insurance.