Raise your hand if you’re familiar with this saying: “You can’t take it with you.”
It’s a saying we’ve all heard, probably many times, and it refers to the stuff and wealth we accumulate. But technically, it could also apply to debt.
Because debt doesn’t necessarily disappear when you pass away; your debts still belong to your estate, which means your spouse and/or heirs may have to deal with them after you’re gone.
Credit life insurance is a tool that can help with paying off a debt. Mortgage protection insurance is one form it takes. Knowing that you aren’t leaving your loved ones with that debt is reassuring, but is credit life insurance the best option?
Here’s what you need to know.
How credit life insurance does it work?
Credit life insurance is a type of life insurance that’s specifically designed to pay off a particular debt if the policyholder dies while the policy is in force.
This type of life insurance is usually sold by banks and lenders. If you’ve ever applied for a mortgage, car loan, personal loan or line of credit, you may have been offered a credit life insurance policy.
For some of these policies, the face value is tied to the balance on the debt. As you pay down the loan, the face value of the policy decreases. When you pass away, the proceeds of the policy pay off the remaining balance. Level death benefit policies are available but tend to be more costly.
Should you consider buying credit life insurance coverage?
The main benefit of credit life insurance is that it will pay off your debt when you pass away. There are two reasons why that’s a good thing.
First, it can simplify what happens to your estate after you die. Normally, your executor is responsible for taking stock of everything you own and everyone you owe, then repaying any debts from your estate’s assets. A credit life insurance policy would keep that specific debt from being a drain on your estate, potentially leaving more assets to pass on to your heirs as part of your financial legacy.
Second, credit life insurance can protect co-borrowers, joint account holders and/or your spouse if you live in a community property state. Ordinarily, those individuals would be on the hook for any shared debts but a credit life policy could pay off a covered debt.
Another good thing is that credit life insurance is generally not tied to your health. Unlike traditional life insurance, there’s no health exam to qualify. This coverage is completely voluntary; you either sign up for it or you don’t.
Next, some credit life insurance policies pay off the debt in the event the policyholder becomes disabled and can no longer work to earn money.
You can purchase credit life insurance even if you’re not in good health, so it may be a good option for a consumer with a medical condition that renders him/her ineligible for term life insurance at an affordable price (or at all). Potentially getting coverage for your full loan balance gives credit life insurance an edge over most guaranteed issue life insurance policies, which also require no medical exam, but typically max out at about $50,000 in coverage. Note that some credit life policies cap the death benefit.
As with most things in life, you’ll need to weigh the pros and cons. Here are a few possible disadvantages to weigh against those benefits.
Credit life insurance cost vs. coverage
Credit life insurance rates typically depend on the original loan balance, the type of credit you’re insuring and the type of policy.
Credit life insurance generally costs more than term life insurance
Most importantly, the price is usually much higher for credit life insurance than it is for term life insurance with a comparable death benefit. If you opt for credit life insurance over term life insurance, you could end up with far less coverage for the same premium. You may be able to get more for your money with a term life insurance policy instead. Why? Because credit life insurance is generally a guaranteed issue life insurance policy and all applicants are approved for coverage regardless of their health. With term life insurance, you usually pay a lower rate than guaranteed issue policies because term life insurance is medically underwritten, meaning your rate is based on the risk you pose to the life insurer. So the healthier you are, the lower your premiums are likely to be with term life insurance.
Typically, credit life insurance is not a separate bill to pay; the premiums are added to your monthly loan payment. That keeps things simple, but the downside is that the term length is often locked in and tied to the loan term. On some policies, a single lump sum premium for credit life insurance is added to your beginning loan balance. In this case, your coverage may cost even more because you’ll pay interest on your premiums for the life of the loan.
With a term life insurance policy, you could choose a coverage duration, typically of 10, 15, 20 or 30 years, and if the policy is level premium, the premium will stay the same until the end of the coverage duration.
Credit life insurance is associated with a diminishing face value
With most credit life insurance, the policy’s face value steadily decreases over time as you pay off the loan. Essentially, you’ll be paying the same premium rate for less and less coverage as time goes by.
Credit life insurance is not the same as decreasing term life insurance. The latter types of policies are not tied to a particular debt and typically last from one to 30 years, with a death benefit that decreases at predetermined intervals. At the time of purchase, a decreasing life policy may be cheaper than a level term life insurance policy with an equivalent death benefit at the onset of coverage. But over time, you may find that you are paying more for your coverage than you would with a level term policy with a comparable (or possibly higher) death benefit, depending on your age and health.
Credit life insurance is limited in how benefits may be used
Another drawback: Credit life insurance is not designed to wipe out all of your debts. This kind of coverage is typically tied to a single installment loan like a mortgage or other personal loan. You’d need to check with each lender you borrow from to find out if coverage is available and how much it costs.
Next, the policy proceeds are generally not paid to your beneficiaries. Instead, the proceeds go straight to your creditors. There’s no flexibility in how the policy can be used. You might not mind that if your only goal is paying off your debt. But if your loved ones would prefer to pay off a different debt first, or if you want to leave them with financial resources and the flexibility to use the funds toward the expenses of their choice, credit life insurance comes up short.
Why term life insurance might be a better choice
Depending upon the amount of coverage purchased and the number of obligations beneficiaries may be left with, term life insurance may have the potential to fill in the gaps that credit life insurance may leave behind.
While a term life insurance policy can certainly be used to help pay off debts, including student loans, credit cards or other debts not covered by credit life insurance, your beneficiaries could put the proceeds to work in other ways, too. For example, your spouse or loved ones can use term life insurance proceeds to:
- Help pay for burial and final expenses
- Help cover day to day living expenses
- Help pay for care for a special needs child
- Establish a college fund for your children
- Set up a charitable trust
Term life insurance is adaptable to what your family needs. When you pass away, the policy proceeds are paid out directly to the beneficiaries. They can decide how to best use the money.
Unlike credit life insurance, neither the face value nor the premium amount on a term life insurance policy with level premiums will change during the term. Also, you’ll choose the term that makes the most sense for you, even if it doesn’t match up with the number of years left on a particular loan.
Cost of credit life insurance vs. term life insurance
Cost-wise, term life insurance is generally most affordable when you’re young and healthy than credit life insurance.
For example, a 30-year-old man in excellent health could get a 30-year, $500,000 Haven Term policy issued by MassMutual for as little as $22.48 per month. The same 30-year-old man would pay $30.83 per month for credit life insurance on a loan with a starting balance of just $50,000, according to the State of Wisconsin Department of Financial Institutions. That’s just one-tenth the coverage of the term life insurance policy in the example above, for around the same price.
You might be able to find credit life insurance with a lower premium, but it’s a good idea to carefully review and compare your options. Over time, you may find that you could get more coverage and pay less with term life insurance, if approved.
Run the numbers on term life coverage
Getting term life insurance may make sense if you’re insurable, you want to provide your loved ones with a financial safety net that won’t decrease in value over time, and that could potentially do more for them than just pay off debts. If you’re on the fence about term life insurance versus credit life insurance, calculate how much life insurance you need. Then, estimate your policy rates to see how much you might pay for your coverage. In the long run, you might find that term life insurance can be a smarter and more affordable choice, and at a minimum, you’ll have an easier time deciding which works for your situation.
Rebecca Lake is a freelance writer specializing in personal finance and small business. She lives on the North Carolina coast with her two children. Opinions are her own.