Estate planning can help you create a comprehensive blueprint for handling your finances during your lifetime and beyond. An essential part of that plan centers on what will happen to any debts you may owe after you pass away.
Leaving your loved ones to deal with an outstanding mortgage, credit cards, student loans, or other debts can create an undue financial burden.
Credit life insurance, also known simply as credit insurance, is designed to help reduce that burden, although it may not be appropriate for every estate plan. Learn more about whether credit life insurance is the right choice for you.
What Is Credit Life Insurance?
Credit life insurance is insurance that's intended to pay off a borrower's debts at their death.
Credit life insurance policies are typically associated with major loans. If you take out a mortgage to buy a home, for example, or a large car loan, you may receive offers for credit life policies.
Many lenders will include credit insurance in your loan proposal. However, it is illegal for them to include it in your final loan agreement without your permission.
Credit life insurance is one of four types of credit insurance. The others are:
- Credit disability insurance, which covers the repayment of a loan if you become disabled and can no longer make payments
- Credit property insurance, which protects any personal property you used to secure the loan in the case of accident, theft, or a natural disaster
- Involuntary unemployment insurance, which makes payments on your loan if you lose your job through no fault of your own
Credit Life Insurance vs. Traditional Life Insurance
Credit life insurance policies are different from traditional life insurance coverage because of the way the death benefit is structured.
With a common type of life insurance such as whole life insurance, the death benefit is determined at the time you purchase the policy. For example, you may purchase $100,000, $500,000, or $1 million in coverage. When you die, the beneficiary receives this predetermined amount.
With credit life insurance, the face value of the policy corresponds to the value of the loan it's designed to pay off. The value of the policy can decline over time as the balance of the loan declines.
For example, if you take out a credit life insurance policy to cover a $400,000 mortgage, the payout will equal the remaining mortgage at the time of your death. If you have paid off $170,000 of the mortgage before you die, your beneficiary will receive a $230,000 payout, which is equal to the remaining value of the mortgage.
Pros of Credit Life Insurance
There are a number of benefits that credit life insurance provides.
Peace of Mind for Loved Ones
Credit life insurance takes the responsibility of paying your mortgage or other debts off the shoulders of your loved ones when you pass away. That can be particularly important if you share a debt, like a home loan, with your spouse or someone else.
Joint borrowers would ordinarily become solely responsible for repaying loans or other debts if a co-borrower dies. A credit life insurance policy, however, would pay the debt for them.
Ease of Qualifying
Credit life insurance can also be easier to qualify for than traditional life insurance.
Many insurance companies require you to go undergo health screening to qualify for traditional life insurance. If you're in poor health, you may face a high premium or be denied altogether.
While health may still be a consideration for credit life insurance, these policies typically have less stringent guidelines for approval.
Cons of Credit Life Insurance
Credit life insurance policies also come with downsides compared to other types of life insurance.
One of the biggest arguments against credit life insurance is that it doesn't do anything that a traditional life insurance policy cannot. If you have a term life policy, for example, your spouse could just as easily use that to pay off your mortgage or other debts.
Loss of Value
The fact that a credit life insurance policy loses value is another potential downside.
If you take out a $250,000 mortgage and you owe $125,000 at your death, the policy would only pay enough to cancel out the loan. If you've paid off your mortgage entirely, your beneficiary receives nothing.
If you have a $125,000 mortgage and a $250,000 life insurance policy, by contrast, your beneficiary can pay off your mortgage and still have funds left over. They could use the difference to pay for burial expenses, set aside money for your children's education, or simply cover day-to-day living expenses.
Cost is another consideration with credit life insurance. The amount you'll pay for coverage depends on the type of credit that's covered, the amount owed, and the type of policy. However, premiums for credit insurance are usually higher than traditional life insurance because of the higher degree of risk.
The premiums you pay on your policy will likely remain the same, even once the payout benefit of your policy decreases. This is another reason credit insurance is more expensive than traditional life insurance.
How you pay the premiums is also important. If you have single premium coverage, for example, the premium may be built into your mortgage automatically. This can raise the total cost of buying a home because it increases your loan amount and results in paying more in interest over time.
A policy that features monthly premiums may be more cost-friendly but the size of the policy matters. And there may be limits on how much in loan value can be covered by a credit life policy.
If you have a larger mortgage, a credit insurance policy may fall short. Not only can purchasing a basic term life policy be more cost-effective, but it could also yield more rewards for your beneficiaries in the long-run.
Do You Need Credit Life Insurance?
Whether or not credit life insurance is a good choice for you depends on your individual financial situation, as well as your health.
- If you're in poor health and aren't able to qualify for traditional life insurance coverage, a credit life policy can shield your loved ones from having to take on your debts.
- If you're healthy and can qualify for a low premium, term life insurance may provide a greater benefit and more flexibility for your loved ones.
As with any type of life insurance, it's important to evaluate the costs, coverage, and whether any exclusions apply. You should also consider how premiums are paid and how long the policy coverage lasts.
Credit life insurance can protect your beneficiaries and keep them from having to use other assets in your estates to pay debts, but life insurance can achieve the same goal. Considering both options can help you create a more effective estate plan.