Credit Insurance 101

What Is Credit Insurance and Do You Need It?

Credit Insurance 101
January 7, 2014

Credit insurance is a form of insurance on a specific debt. It could be a home or car loan, a credit card balance, or any other form of debt. By purchasing credit insurance, you are guaranteeing that the debt will be at least partially paid under the condition the specific policy was written for (death, disability, etc.).

Types of Credit Insurance

There are five main categories of credit insurance:

  • Credit Life Insurance- This covers the specific debt or loan if you die during the policy term. It may pay all or only part of the expense.

  • Credit Disability Insurance - This provides limited monthly payments on a specific debt if you cannot work due to illness or injury during the term of coverage. Another name for this type of policy is credit accident and health insurance.

  • Credit Involuntary Unemployment Insurance - This pays off a prescribed number of monthly loan payments if you lose your job due to a layoff or other involuntary reason (within limits). Another name for this type of policy is involuntary loss-of-income insurance.

  • Credit Property Insurance - This protects items purchased on credit from theft, accidents, natural disasters, or similar loss mechanisms as described in the policy. Credit property insurance is different in one important way — it is not related to your ability to repay the debt in question.

  • Credit Card Insurance – Many of the insurance protections described above may be bundled into a single “credit card insurance” policy. This form of credit card insurance is typically offered at the time the credit card is first issued by the card issuer.

(The forms of credit insurance listed above are intended to protect consumers. There is also a specialized form of credit insurance -- known as bad debt insurance -- for the other side of the credit transaction. These policies target businesses and protect them against high default rates on their accounts receivable.)

Credit Insurance Premiums

Premiums for credit insurance may be in the form of single payments, fixed monthly payments, or variable payments related to a changing monthly debt balance.

  • Single payments are often included in the total amount of money borrowed (thus paid up front but increasing the monthly payment amount since you are borrowing the money for the premium).

  • Fixed monthly payments are closed–end payments that are due each month regardless of the debt amount.

  • Variable monthly payments are open-ended payments that are calculated on a monthly outstanding balance (MOB). The calculation basis could be an end-of-month debt total or an average daily balance. Credit cards often carry this sort of payment scheme. Your payment should appear as a separate line item charge for the month.

Do You Need Credit Insurance?

Now that we’ve examined what credit insurance is, and how it is paid for, it’s time to ask the pivotal question: Do you need credit insurance on that car loan, mortgage or credit card? You should consider a few questions before answering.

  • What is your main risk concern? (For example, do you have a job that is at a high risk for physical injury or being laid off?)

  • What exactly are the insurance benefits you are paying for? (For example, if you become disabled, will the policy simply make the minimum payments for a set term, or will your debt be paid off in full?)

  • What is the cost of these benefits and is their value proportional to this cost? (For example, if you’re paying $1 in premium to insure every $100 of a credit card balance -- and the insurance simply makes your minimum payments for a limited term if you are laid off or disabled – is it worth the high cost of this protection?)

  • Do you already have coverage through an existing disability or life insurance policy, and if not, would that be a more cost-effective option for you?

Assess all policy terms before doing a cost/benefit analysis. For example, if a disability policy has a waiting period and only covers part of the payments, you would have to be unable to work for a long time for benefits to exceed premium costs. So be smart and consider payment terms, waiting periods, limits, exclusions and cancellation requirements before purchasing any form of credit insurance.

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