What Is Credit Life Insurance?
Credit life insurance is a an insurance policy that pays off a policyholder’s outstanding debts if they die. The coverage declines as the debt is repaid over time. Credit life insurance can protect a co-signer or dependents from financial liability and is commonly offered for mortgages, car loans, and lines of credit. This kind of life insurance differentiates from term life insurance in beneficiary designation and value. Bear in mind that heirs, excluding those in community property states, generally do not inherit debt.
Key Takeaways
- Credit life insurance is designed to pay off a borrower’s outstanding loans if the borrower dies, making it particularly valuable for those with co-signers or dependents.
- Unlike term life insurance, credit life insurance decreases in coverage as the loan balance decreases, and the payout goes directly to the lender rather than to heirs.
- Credit life insurance is considered a guaranteed issue policy with generally less stringent underwriting requirements, often not requiring a medical exam.
- While the lender is the beneficiary of a credit life insurance policy, it is illegal for lenders to require this insurance as a condition for a loan.
- Compared to credit life insurance, term life insurance can provide beneficiaries with more flexible financial support, as the benefits are paid directly to them to manage as needed.
Understanding the Mechanics of Credit Life Insurance
Credit life insurance is typically offered when you borrow a significant amount money, such as for a mortgage, car loan, or large line of credit. The policy pays off the loan in the event the borrower dies.
Such policies are worth considering if you have a co-signer on the loan or you have dependents who rely on the underlying asset, such your home. If you have a co-signer on your mortgage, credit life insurance would protect them from having to make loan payments after your death.
In most cases, heirs who aren’t co-signers on your loans aren’t obligated to pay off your loans when you die. Your debts are generally not inherited. The exceptions are the few states that recognize community property, but even then only a spouse could be liable for your debts—not your children.
When banks loan money, part of the risk they accept is that the borrower might die before the loan is repaid. Credit life insurance protects the lender and, by default, also helps ensure your heirs will receive your assets.
Fast Fact
The payout on a credit life insurance policy goes to the lender, not to your heirs. Although, it is against the law for lenders to require credit insurance.
Exploring Alternatives to Credit Life Insurance
If your goal is to protect your beneficiaries from being responsible for paying off your debts after you die, conventional term life insurance may make the most sense. With term life insurance, the benefit will be paid to your beneficiary instead of the lender.
Then, your beneficiary can use some or all of the proceeds to pay off debt as they need. Term coverage from a life insurance company is usually more affordable than credit life insurance for the same coverage amount.
Moreover, credit life insurance drops in value over the course of the policy, since it only covers the outstanding balance on the loan. In contrast, the value of a term life insurance policy stays the same.
Benefits of Choosing Credit Life Insurance
One advantage of a credit life insurance policy over a term life insurance policy is that a credit insurance policy often has less stringent health screening requirements. In many cases, credit life insurance is a guaranteed issue life insurance policy that does not require a medical exam at all.
By contrast, term life insurance is typically contingent on a medical exam. Even if you’re in good health, the premium price on term insurance will be higher if you purchase it when you are older.
Credit life insurance will always be voluntary. It is against the law for lenders to require credit life insurance for a loan, and they may not base their lending decisions on whether or not you accept credit life insurance.
However, credit life insurance may be built into a loan, which would increase your monthly payments higher. Ask your lender about the role of credit life insurance on any major loan you have.
Who is the beneficiary of a credit life policy?
The beneficiary of a credit life insurance policy is the lender that provided the funds for the debt being insured. The lender is the sole beneficiary, so your heirs will not receive a benefit from this type of policy.
Do you need credit insurance?
While credit life insurance is sometimes built into a loan, lenders may not require it. Basing loan decisions on acceptance of credit life insurance is also prohibited by federal law.
What is the aim of credit life insurance?
One main goal of getting credit life insurance is to protect your heirs from being saddled with outstanding loan payments in the event of your death. Credit life insurance can protect a co-signer on the loan from having to repay the debt.
The Bottom Line
Credit life insurance is designed to pay off a borrower’s specific debts if they pass away, ensuring that co-signers and heirs are protected from residual financial obligations. The death benefit decreases over time, in line with the diminishing loan balance, providing coverage tailored to the amount owed. It’s important to understand that lenders cannot require credit life insurance; it should be a voluntary decision made by borrowers. While credit life insurance can offer peace of mind without stringent underwriting, conventional term life insurance might offer broader coverage potentially at a lower cost, providing the financial benefit directly to heirs instead of to lenders.
