What is credit insurance?


In a Nutshell

Credit insurance can help protect a personal loan by paying your monthly loan bill if you become unemployed or disabled, or by paying all or part of your loan if you pass away. But credit insurance may not be all it’s cracked up to be. It can be expensive, and it may not be worth it if you already have disability or life insurance.

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When you borrow money, the thought of not being able to repay it can be scary.

Depending on the specific type of credit insurance offered, it may offer protection from missed payments in case of unemployment, disability, death or destruction of the property you financed with your loan. Policies can be available on many types of loans, including home mortgages, personal loans, credit cards, auto loans, and loans for furniture or appliances.

Credit insurance may be more expensive than a life or disability insurance policy, both of which may provide broader protection for the events those policies would typically cover — so think carefully before buying credit insurance.

Let’s take a look at how credit insurance works, what it costs and what you need to know if you’re considering this type of coverage.

How does credit insurance work?

Credit insurance is coverage for your making your loan payments if you become unable to make those payments yourself, for the reasons covered by the specific policy. A credit insurance policy can possibly be purchased directly from your lender when you get your loan. While you generally can’t be required to buy credit insurance, this type of protection may be marketed to you when you borrow or may be included in your loan paperwork. But your lender must make clear what’s being offered to you when it comes to credit insurance, and the FTC says it’s actually illegal for a lender to deceptively include credit insurance in your loan without your permission or knowledge.

To be guaranteed approval, there may be eligibility requirements with some credit insurance policies but not with others.

Types of credit insurance

There are four main types of credit insurance.

1. Credit disability insurance: Makes payments to your lender if you become injured or sick and can’t work. It’s also called “accident and health insurance.”

2. Involuntary unemployment insurance: Makes payments to your lender if you’re laid off or otherwise lose your job through no fault of your own. It’s also called involuntary loss of income insurance.

3. Credit property insurance: Provides coverage for personal property that was acting as collateral for the loan if it’s destroyed by an accident, theft or natural disaster.

4. Credit life insurance: May pay off some or all of your remaining loan balance to your lender if you pass away.

How much does credit insurance cost?

Credit insurance can be more expensive than other types of insurance. According to the State of Wisconsin Department of Financial Institutions, the annual cost for credit life insurance for a 30 year old in good health is approximately $370 for $50,000 of coverage, compared to $78 for term life insurance.

Credit insurance premium costs vary widely, because they may be determined by a number of different factors, such as …

  • The type of loan or credit you’re getting
  • The amount of debt that will be protected
  • The type of credit insurance policy you choose

Your insurance costs and the way you’re charged for coverage may also depend on whether your debt is open- or closed-end.

Open- vs. closed-end credit

Open-end credit (also known as revolving credit) allows you to borrow more at any time, up to your credit limit, often with a credit card. There’s no fixed repayment schedule to pay back the balance in full, although there is usually a monthly minimum payment amount.

With open-end credit, the cost of credit insurance may be charged via the monthly premium method. This means that the credit insurance premium each month is calculated on a monthly basis — either by the average daily balance or the balance at the end of the month. Your policy will specify which calculation method is used.

The monthly insurance cost will be part of your minimum monthly payment. This charge should be displayed separately on your loan or credit card statement.

Closed-end loans are repaid over a fixed timeline, in which you are required to have paid off your entire balance. Installment loans, like most auto and personal loans, that are repaid on a monthly basis are common examples of closed-end loans.

With closed-end loans, the cost of your credit insurance may be included as a monthly premium or single premium option.

With a single premium, the insurance cost is set at the beginning of the loan and added to the amount you originally borrow, increasing both the amount borrowed and the amount of interest you’ll pay. If calculated as a monthly premium, then the outstanding balance in the account on the monthly billing date is multiplied by the premium rate.

Things to consider before buying credit insurance

If you’re considering credit insurance, here are a few things to know.

Credit insurance is optional

Lenders sometimes include credit insurance automatically in their loan paperwork, but you aren’t obligated to buy it. In fact, according to the FTC, it’s against the law for a lender to deceptively add credit insurance coverage to your loan without your knowledge. Be sure to ask your lender if the loan includes any credit insurance charges.

If a lender pressures you to buy credit insurance or denies you a loan if you refuse to buy it, the Federal Trade Commission recommends you report the lender to your state insurance commissioner, state attorney general or directly to the FTC.

You may not need it

Depending on the types of insurance you might already have, you may not even need credit insurance. For example, if you already have disability or life insurance, these policies may be enough.

If you don’t already have other insurance that covers debt, compare the cost of credit insurance to that of other types of insurance. It may be less expensive to get another type of insurance that may pay you or your family, versus your lender, if something were to happen.

Some policies have restrictions

Before you sign on the dotted line, make sure you understand all the details of the credit insurance policy being offered. Some policies have waiting periods or exclusions. For example, with certain credit disability insurance policies, if you file a claim within the first six months of the policy because of a health condition you were treated for up to six months before you got the credit insurance, your claim could be denied.

The FTC also suggests asking other questions.

  • Whether you can cancel the insurance and, if so, whether you would receive a refund
  • If you’ll have coverage for the full loan amount until it’s paid off
  • Whether a co-signer is covered and if there is an additional cost for their coverage, if you have a co-signer

Bottom line

While credit insurance may seem like a smart purchase at first, it can add significant costs to your loan. If you decide to buy it, make sure you fully understand the policy terms and any limitations.

If you have reservations about credit insurance, you may want to consider setting aside the money you’d pay for coverage instead. This way, you’d have a fund you could pull from if you come up short for one or more months.