Credit life insurance
What is credit life insurance?
Credit life insurance is a type of life insurance policy designed to pay off a borrower’s unpaid debts if the borrower dies. The face value of a credit life insurance policy decreases in proportion to the outstanding loan amount as the loan is paid off over time, until both reach zero.
How Credit Life Insurance Works
Credit life insurance is typically offered when you borrow money, when you close a mortgage, when you take out a car loan, or when you open a line of credit. The policy will reimburse the loan if the borrower dies. If your spouse or someone else is a co-signer on your mortgage, credit life insurance will protect them from loan repayments after your death. Such policies are worth considering if you are the primary breadwinner and the co-signer on the loan would have difficulty making the payments if you die.
In most cases, heirs who are not co-signatories of your loans are not required to repay your loans upon your death; debts are generally not inherited. The exceptions are the few states that recognize community property, but even then, only a spouse could be responsible for your debts, not your children. When banks lend money, part of their accepted risk is that the borrower will die before the loan is paid off. In reality, credit life insurance protects the lender, not your heirs. In fact, the payment for a credit life insurance policy goes directly to the lender, not your heirs.
Key points to remember
- Credit life insurance is a specialized type of policy intended to pay off specific outstanding debts in the event the borrower dies before the debt is fully repaid.
- It may be required in certain situations.
- Credit life insurance policies have a term that corresponds to the maturity of the loan and the decrease in death benefits, which in turn corresponds to the reduction in outstanding debt over time.
- Credit life insurance policies, due to their specific nature, often have less stringent underwriting requirements.
Credit life insurance is one way to protect a joint borrower
If your goal is to protect a spouse from paying off your debts after your death, conventional term life insurance may make the most sense. In this case, the value of the policy will be paid to your spouse, tax-free, upon your death. Some or all of the proceeds can be used to pay off debt. Term coverage from a life insurance company is generally cheaper than credit life insurance for the same amount of coverage.
In addition, borrower insurance loses its value during the contract, since it only covers the outstanding balance of the loan; the value of a term life insurance policy remains the same.
No medical exam required
One of the advantages of a credit life insurance policy is that it often requires a less strict medical examination and, in many cases, no medical examination. This is called guaranteed issue life insurance. In contrast, term life insurance is almost always subject to a medical examination; even if you are in good health, the premium price will be higher if you are older.
Credit life insurance is voluntary
Requiring credit life insurance in a loan is against federal law, as is basing loan decisions on the acceptance of credit life insurance. However, sometimes credit life insurance is built into a loan, which increases your monthly payments, so it’s important to talk to your lender.
The bottom line
Credit life insurance pays off a borrower’s debts if the borrower dies. You can usually buy it from a bank when you close a mortgage, take out a line of credit, or get a car loan. This type of insurance is especially important if your spouse or someone else is a co-signer on the loan in order to protect them from paying off the debt. It also protects your spouse or heirs in states where heirs are not protected against unpaid debts from a parent.
Do you need credit insurance?
Although credit life insurance is sometimes built into a loan, requiring it is against federal law. It is also prohibited to base lending decisions on the acceptance of credit life insurance.
What is the purpose of credit life insurance?
The main objective is to protect the heirs against arrears in repayment of the loan in the event of death. This is especially important if your spouse or someone else is a co-signer on the loan in order to protect them from having to repay the debt. It also protects your spouse or heirs in states where heirs are not protected against unpaid debts from a parent.