Credit life insurance

Credit life insurance is an 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 loan’s value. In the event of your untimely death, this policy would 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?

The term “credit life insurance” is a misnomer that can cause some confusion. A contract for credit life insurance is for a specific loan, and while it does pay out in the event of the policyholder’s death, the payout can only be used to satisfy the loan. Additionally, the agreement only lasts for the life of the loan. This is different from something like permanent life insurance, which is designed to remain in effect for the permanence of your life.

Adding to the confusion, “credit life” is also a marketing slogan sometimes used with standard life insurance policies, with which insurance agents might suggest that regular life insurance is a means to pay off a 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.

Once the loan is paid in full, the credit life insurance contract is up and does not apply to any other loan or expense not specified in the agreement.

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Whole life insurance combines life insurance with an investment component.

• Coverage for life
• Tax-deferred savings benefit if premiums are paid
• 3 variations of permanent insurance: whole life, universal life and variable life include investment component

Term life insurance is precisely what the name implies: an insurance policy that is good for a specific term of time.

• Fixed premium over term
• No savings benefits
• Outliving policy or policy cancellation results in no money back

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What does credit life insurance cover?

Credit life insurance usually covers any remaining debt 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. The title to the underlying asset is then transferred free and clear to the borrower’s estate and, ultimately, to the estate’s beneficiaries.

According to Kevin Lynch, assistant professor of insurance at The American College in Bryn Mawr, Pa., 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 the mortgage if one or both of you dies before paying off the loan. This type of protection could be especially helpful if the remaining spouse relied on both incomes to cover the loan payments.

Credit life insurance may also be offered to cover the following types of loans:

• Student loans
• Credit card loans
• Open lines of credit
• Personal loans

How much does credit life insurance cost?

While credit life insurance rates will depend on the loan amount, these types of insurance policies typically cost more than traditional life insurance. Multiple factors 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.

Credit life insurance is perceived as a higher risk because it’s 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 does not need to take medical exam or disclose health details because what is being insured is the balance of the loan, not the life of the borrower, explains Lynch.

Things to consider before buying credit life insurance

Since credit life insurance may cost more than regular life insurance and primarily provides financial protection for 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 wish to protect the co-signer on your loan: With a credit life insurance policy, the co-signer will not be responsible for the remainder of the loan.
• You cannot buy life insurance through regular channels because of the medical exam: Credit life insurance does not require a medical exam, so it may be a worthwhile option for people in poor health.
• If you cannot qualify for enough life insurance to cover outstanding debts that you may leave behind: Credit life insurance provides a payout to help cover the contracted debt so that your loved ones will not be responsible for them.

On the other hand, you may want to consider alternatives to credit life insurance if you qualify for traditional life insurance that covers the amount of debt you require or if it would not be a burden for your loved ones to pay off the loan without your income.

Credit life insurance and taxes

Taxes generally aren’t a concern with credit life insurance since the policy’s payout is strictly used to pay off the loan. Because family members are not listed as beneficiaries of the policy as with a standard life insurance policy, estate or inheritance tax implications would not apply.

For example, if a couple has a credit life policy on their home loan, and one of them passes away, the policy would effectively remove their obligation to pay further on that loan. The survivor would not be obligated to pay any taxes on the policy payout that covers the insured debt.

Alternatives to credit life insurance

Credit life insurance is not the only option for insuring your debts in the event of an untimely death. Consumers who do not want to obtain credit life insurance might want to consider one of these alternatives:

Existing life insurance

The simplest option may be to increase the amount of your current life insurance policy, if you already have one in place. You may need to complete another health assessment to qualify for increased limits, but you can always lower the amount of the policy once you have paid the loan. Another option is to allocate a certain portion of the existing coverage limit to cover your loan.

Term life insurance

Term life insurance might be a good option for those who only want coverage for a limited timeframe and 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 and you can select a beneficiary of your choosing.

Savings accounts

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 to pay off the loan balance if you pass away.

Frequently asked questions

• • Does credit life insurance require a medical exam?

    No, as credit life insurance covers a loan instead of a policyholder’s death benefit, 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 covers a loan instead of an individual, exclusions are far less common than with traditional life insurance.

  • How much credit life insurance do I need?

    The amount of credit life insurance you need will vary based on your outstanding debt. For example, if you opt to purchase credit life insurance on your new vehicle, you will need the policy to cover the remaining cost of that vehicle.

  • Is there a maximum amount of credit life insurance I can purchase?

    Because credit life insurance specifically exists to cover the remaining debt on a loan, the maximum amount of insurance typically cannot exceed the amount of your loan. However, maximum coverage amounts — which vary by state — may still exist to prevent excessive credit loans.