If you have a mortgage, auto loan, or balances on credit cards, you may be interested in the best strategy to pay off your debts in the event of your death.
Perhaps you’ve even received credit life insurance offers from a lender, and wonder how it works, and whether or not it’s a good deal.
In this article, I’ll explain what credit life insurance is, why it’s a no-brainer, and the lowest cost way to get it.
What Is Credit Life Insurance?
Sometimes referred to as payment protection insurance, the goal of credit life insurance is to pay off your debt — such as a home loan or credit card debt — in the event of your passing.
Types of debt you could pay off with credit life insurance include:
- Auto loan
- Student loan debt
- Personal loan
- Credit card debt
And there are two general avenues people use to pay these debts off:
- Traditional life insurance: You buy a life insurance policy, such as term life insurance, and name your heirs or estate as the beneficiary of the policy with the intention they’ll use the funds to pay off your creditors. You choose the amount and length of coverage and the death benefit typically stays level throughout the life of the policy.
- Credit life insurance: A unique type of life insurance policy in which the death benefit is tied to the amount you owe your creditor. You name your creditor as the beneficiary to the policy and the death benefit typically decreases with your loan balance.
Two Reasons You Need It
When you pass away, in most states, your debt (debt only in your name) does not pass on to your family or spouse.
So, if you have $20,000 of credit card debt, you don’t have to worry about sticking a family member with the responsibility of paying that off if you were to die unexpectedly.
But there are at least two instances when you need credit life insurance.
Your Estate Is Responsible
First, according to NerdWallet, your estate is responsible for your debts after you die.
So, if you pass away with any assets, such as a bank account, investments, a house, vehicles, or a business, the executor of your estate will need to use your assets to pay off your debts before your heirs get a penny.
This is handled through probate.
So even if your family may not technically be responsible for your debts, the debts can certainly eat up the assets you had hoped to leave them.
And if you own a business or property and no liquid assets exist to pay off debts at the time of your passing, your executor could have to sell these assets to raise funds to pay off your debt.
If you’ve earned equity in your home or have a high-value business, you might cringe thinking of your executor selling your business in a fire sale to pay off some credit card debt.
Your Co-Signer Could Suffer
Second, if you have a co-signer or co-accountholder on a loan or credit card, your death will not result in the wipeout of your debt.
Instead, they will continue to owe and need to make all payment obligations to your creditor.
If they are left without your income or any money to help, they could struggle to make timely payments, which could hurt their credit score or even result in defaulting on the debt.
How Does Credit Life Insurance Work?
So, now that you understand what credit life insurance is, what it can pay off, and why you might need it, let’s talk about how it works.
To start, we need to reframe the way you think about life insurance.
You see, when most people think of buying life insurance, they think of working with an agent or reaching out to buy it directly from a company like Ethos Life or Policygenius. Sometimes a medical exam may be required and sometimes not, and pricing is typically competitive.
Credit life insurance is unique in that the offers typically come to you by mail from an insurance company working in tandem with your lender or by simply checking a box to include the insurance on your loan application.
The approval process is extremely streamlined, requiring nothing more than answering a couple application questions such as relating to gender and smoking status — no medical exam required. Some of the policies are “guaranteed issue,” meaning there are no questions at all.
Pros and Cons of Credit Life Insurance
Because of the streamlined application process, buying credit life insurance is incredibly fast and convenient.
But you pay a premium (pun intended) for that convenience.
Since the insurance company knows dangerously little about you, they have to charge you a lot more money to cover their potential risk. As a result, the typical credit life insurance policy costs three to four times what you’d pay if you purchased a similar policy through Policygenius.
According to Wisconsin’s Department of Financial Institutions (WDFI), the average annual premiums for a credit life insurance policy for a 30-year-old is around $370 vs. only $78 per year for a traditional term life insurance policy.
The following are a couple of other caveats.
It Mostly Helps the Creditor
If you’re considering credit life insurance, you need to understand that it pays out directly to the creditor, so from its infancy, its purpose is to protect the lender.
That’s one of the reasons they get in cahoots with the insurance companies to pitch you on life insurance!
While it can be beneficial if you have a co-signer or co-accountholder, live in a community property state, or have a large number of assets to leave behind to your family, just remember the purpose of these policies is to make your creditor whole, without leaving any additional funds to your family or estate.
The Coverage Decreases (Over Time)
Another downside to this type of product is that the coverage amount usually decreases over time as you start to pay down your debts. Meanwhile, the premiums remain level.
This happens because you are only covered for the amount that you owe.
For example, say you have a 30-year, $500,000 mortgage and you get a credit life insurance policy for $50.00 per month. Over time, as your mortgage balance decreases, so will the value of the policy.
So, by year 10, let’s say you owe $400,000 on your mortgage. This would also mean that your mortgage life insurance, or credit life insurance policy, would only have a value of $400,000 (but your monthly premium of $50.00 would stay the same!).
By contrast, the death benefit of a traditional term life insurance policy does not decrease over time. According to DollarSprout, a term policy offers a level coverage amount for the duration of the term length you choose, such as 10, 15, 20, or 30 years.
Is Credit Life Insurance Worth It?
In all honesty, it probably isn’t worth buying credit life insurance when you compare it to buying a traditional life insurance policy. In the traditional route, you can still go directly to a company and find convenient policies that don’t require a medical exam, but the cost is much lower and your death benefit remains level. Let’s check out the chart below:
Credit Life Insurance
Traditional Life Insurance
Coverage decreases over policy term
Coverage never decreases over policy term
Premium stays level
Premium stays level
Policy pays out only to creditor
Policy pays out to your beneficiary
Can only pay off specific debt
Can be used to pay for anything
Higher costs for lower coverage
Lower costs for more coverage
From the chart above, you can quickly start to see why it’s probably more beneficial to purchase a standard term life insurance policy over a credit life insurance policy.
Traditional Life Insurance: The Low-Cost “Credit Insurance” Alternative
By going the traditional life insurance route, you could get a life insurance policy that covers all of your debts. Over time, as you pay down your balances, your coverage amount would stay the same so that, in the event of your death, all your debts could be paid and anything left over would go to your family.
Here’s a quick comparison: Say you pay off $300,000 of your $500,000 mortgage, and then you pass away. Let’s compare using a $500,000 credit life insurance policy vs. a traditional policy.
With a credit life insurance policy, the mortgage would be paid off, and your family’s only benefit would be being able to keep their home and live in it mortgage-free.
However, if you did the same thing with a traditional life insurance policy, your family could pay the remaining $200,000 on the mortgage and keep $300,000 to use for whatever else they needed. It’s a win for your creditors, but an even better win for your family.
If you have any debt, it is essential to have some protection for your family when you pass away.
While credit life insurance is an excellent way to clear a debt, it only benefits the creditor in the long run and usually only covers one specific obligation.
There is also no reason to pay higher premiums for credit life insurance and get lower amounts of coverage.
In all honesty, there is no better option than getting life insurance if you need a way to cover your debts and protect your family in the event of your death, and my recommendation is to use traditional life insurance for that coverage rather than credit life insurance. If you’re not sure where to find the best policy, I reveal my personal, top 10 favorite life insurance companies in this guide.