The following is a post by MPFJ staff writer, Kevin Mercadante, who is a freelance professional personal finance blogger for hire, and the owner of his own personal finance blog, OutOfYourRut.com. He has backgrounds in both accounting and the mortgage industry.
Have you ever made a major purchase, and been told that you must pay for a credit life insurance policy in order to get a loan to make that purchase? It’s a common practice, and even though it’s usually not a true requirement, it is almost always presented as though it is. But in most situations, credit life insurance is not a requirement, and represents little more than an extra expense for you.
What is Credit Life Insurance?
Credit life insurance is a form of life insurance that has a single specific purpose. Regular life insurance is usually taken out for a general purpose. The insured purchases a policy for a certain amount of money, which is then paid to his or her beneficiaries at the time of death, and can be used for any purpose.
Credit life insurance, on the other hand, is taken out for the purpose of paying off a single loan upon the death of the insured. The proceeds cannot be used for any other purpose. And in fact, the proceeds don’t even go to the insured’s beneficiaries. Instead, even though the policy is paid for by the insured, the beneficiary is the lender. The proceeds will go to the lender to pay off the remaining balance of the loan at the time of death.
Now even though credit life insurance is for the direct benefit of the lender, there is a secondary benefit to the insured’s family. Because the policy will pay off the loan on the asset, the insured’s heirs will be able to retain ownership of the asset, free of the loan that was used to purchase it.
Credit life insurance is most commonly used in connection with the purchase of a major asset. This can include a house, a car, a boat, furniture or appliances, and computer equipment. Any time an asset is purchased using credit, credit life insurance can enter the picture.
Why Credit Life Insurance is Such a Bad Deal – For You
There are several reasons why credit life insurance is best avoided:
Credit life insurance is expensive. It costs significantly more than an equivalent amount of ordinary life insurance. This is partially true because the amount of the policy is generally small, and life insurance costs proportionally more for smaller amounts.
It is also because credit life insurance comes under the category of guaranteed issue. That’s a term used to describe a policy that does not require you to disclose the condition of your health, nor does it require a medical exam. The insurance company is issuing the policy with no knowledge as to any factors that might affect your mortality.
Declining balance of death benefit. Since credit life insurance is tied to a loan, the death benefit declines in value as the loan amount is paid down. This means that as the loan is amortized, you’re paying proportionately more for less coverage.
Single premium payment. The lender will often require you to pay the full cost of the policy at the time you purchase the asset. In doing so, the premium will be financed into the loan amount. That means that you will be paying interest on the amount of the premium.
Worse, should you pay off the loan early, it is unlikely that you will get a refund of the unapplied premium. More likely, you will forget all about the life insurance policy, and assume that the remaining portion of the premium is simply part of the loan balance that needed to be paid off.
Why Are Companies So Aggressive in Promoting Credit Life Insurance?
Though few lenders or product dealers will admit it openly, it’s extremely likely that they are receiving some sort of incentive in order to promote the use of credit life insurance in conjunction with the purchase of their products. In the simplest terms, credit life insurance represents an additional revenue stream for both the company and its sales staff. They will be strongly encouraged to add credit life insurance to the purchase.
It may also be that in some cases the existence of credit life insurance might help to enable a marginal borrower to get a loan. This is a common requirement with various types of subprime loans. The existence of credit life insurance will eliminate at least one potential risk for the lender, which is the death of the borrower before the loan is repaid.
There may also be certain situations in which a product vendor and the insurance provider are related organizations. It could be that one owns the other, or that they have a common corporate parent. Any of those connections could result in an attempt by each subsidiary to promote the products of another.
Credit Life Insurance is Usually Not a Requirement
Credit life insurance is not supposed to be a requirement for obtaining a mortgage. And depending upon what state you live in, it may not be required for any other type of loan, including auto loans.
But that won’t stop a vendor from selling you a credit life insurance policy. They may even press the notion that it is a requirement. Even though state law may require some sort of disclosure or waiver, the sales staff may bury the document in a thick bundle of paperwork, in the hope that it will be ignored.
They tend to be most successful in promoting credit life insurance in connection with subprime loans. For example, if a person has less-than-perfect credit, they may just be happy to get a loan – any kind of loan – even if it has some expensive requirements. That can include credit life insurance.
How to Avoid Being Trapped into Buying Credit Life Insurance
One of the best ways to avoid being trapped into buying credit life insurance is to maintain good credit. Since the competition to make loans to people with strong credit profiles is so heavy, neither lenders nor vendors will risk including credit life insurance for prime borrowers, who always have the option to go to another source. Maintaining a high credit score will likely prevent the topic from ever even coming up.
You can also check with laws in regard to credit life insurance in your state. The laws vary in each state, and you can never expect a vendor or a lender to tell you what the law is if it doesn’t work in their favor. You need to do your homework and know what the laws are. Get a copy of them, and be prepared to present them when you make your purchase, in the event that anyone tries to push credit life insurance as a requirement.
Another option is to shop. Even if you fall into the subprime credit category, the knowledge that you are working with two or three different vendors could force one of them to drop the credit life insurance requirement in order to win your business.
Credit life insurance is expensive, and works primarily for the benefit of the lender or vendor and not you. For those reasons, you should do everything you can to avoid having to take a policy.
How about you all? What are your thoughts on credit life insurance?
Share your experiences by commenting below!
