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 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 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. 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, credit life insurance is 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. 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 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.
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 is generally the case with mortgage loans, but only in instances where the buyer does not have a down payment of 20 percent of the home’s cost. When that happens, the buyer might have to buy credit life at the lender’s insistence to get the loan.
But there is 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 is 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 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 and there are alternatives. People who do not want to obtain credit life insurance might want to consider one of these alternatives:
Existing life insurance policies
If you have a life insurance policy already in place, your lender may allow you to earmark some of the funds to cover your debt. You will need to confirm with your lender if this is an option and you may need to provide proof of coverage.
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.
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.
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.