Personal loans can cover everything from debt consolidation to medical bills, or even major life events like adoption or a wedding. But before you apply, you should know that monthly payments might not be the only associated cost. Some borrowers also purchase personal loan insurance to protect themselves from defaulting in the event they can’t make payments on time. However, the added security of personal loan insurance can be costly, and in some cases, unnecessary.
What is loan protection insurance?
Most loan protection insurance policies cover certain events for a short-term period, relieving you from having to make payments for a set period, usually between 12 and 24 months. According to the Federal Trade Commission (FTC), there are four types of loan protection insurance, each of which covers different situations.
- Credit life insurance: If you pass away before repaying all of your loans, this policy pays off either some or all of your remaining balance.
- Credit disability insurance: This is sometimes referred to as accident and health insurance, which gives you temporary relief from making payments if you can’t work for health reasons.
- Involuntary unemployment insurance: If you get laid off or lose your job, this policy can cover your loan payments for a while.
- Credit property insurance: When you use personal property as loan collateral, this insurance protects the property itself rather than your loan payments.
Pros and cons of loan protection
The obvious advantage of loan insurance is that you can avoid making late payments or defaulting during circumstances out of your control. Even one late payment can damage your credit score and the more it drops, the more it’ll cost you to access other loans or credit in the future. As with most types of insurance, paying a little bit of money up front could potentially save you a lot in the long term.
On the other hand, just as with other types of insurance, you may not ever need to use your loan protection policy. It’s also important to understand the details of your policy to make sure you’re well covered, since all policies come with exclusions.
What to look out for
You’ll also need to fully understand the claims process so you don’t unwittingly disqualify yourself and miss out on using your insurance on the loan. “It’s very important that you read and understand the fine print in these policies,” warns Bruce McClary, vice president of the National Foundation for Credit Counseling. “And know when you can file a claim.”
McClary cites a case he handled in which a loan customer became injured and couldn’t work. The man knew he’d miss a payment, and he filed his insurance claim after the payment due date had passed.
It turned out the policy didn’t honor claims filed after missed payments. Then the customer racked up late fees on top of the regular payment and had to wait until the account was up to date to try again to file a claim. That caused major stress.
Check on exactly what is covered as well. Missing work because of a pre-existing medical condition, for example, could disqualify you from getting your loan payments covered. There may also be limitations if you’re self-employed or only work part-time. Don’t assume that just because a lender makes you a loan insurance offer that it’s actually designed to meet your personal needs.
Also beware of lenders who tell you that loan protection insurance is mandatory in order to qualify for financing. Credit insurance is usually optional, the FTC says. Don’t believe it if a lender says you must buy the coverage in order to qualify for the loan, because that’s illegal.
The lender also can’t slip in the coverage without your knowledge either. The federal Truth in Lending Act requires that lenders notify the consumer of loan costs, including the cost of credit insurance. If you elect to accept the coverage, you must do so in writing. Of course, only do so if you’re comfortable with the cost and terms, McClary says.
The bottom line
Personal loan insurance isn’t an automatic scam, but there may be limitations to how helpful it actually is. At the end of the day, you need to perform a cost-benefit analysis to make sure the extra policy expense is worth the coverage you receive. Rather than glossing over your plan, pay attention to the details on exclusions and the claims process to maximize your personal loan insurance when you really need it.