Credit life insurance is a policy that protects both your heirs and lenders to whom you may still owe debts when you die. This kind of life insurance is best for people with large outstanding loans who don’t want to pass the balance on to their heirs.
A credit life insurance plan is one option borrowers can utilize to pay back their debts after they die. The goal of a credit life insurance plan is to keep the policyholder’s heirs from taking on any of their debt, while also ensuring the heirs can inherit the policyholder’s assets with a clear title. This type of policy is different than traditional life insurance plans.
If you’re on the fence about whether credit life insurance is right for you, keep reading to learn the pros, cons, and key facts to help you decide.
What is credit life insurance?
Credit life insurance pays off a borrower’s outstanding debts to a lender in the event of their untimely death. Despite being called “life insurance,” credit life insurance isn’t really a life insurance policy. It’s more like loan insurance for the benefit of the lender, but the borrower’s estate receives financial protection from this plan as well.
How it works
Credit life insurance works by putting your insurance premium toward the debt you owe on a loan. By paying off your loan over time while you’re still alive, plus putting your regular insurance premiums toward your debt for later, you’re ensuring that your family members and other heirs will receive clear title to your assets when they inherit your estate. You can think of it like a debt payment plan that continues on your behalf after you die.
Put differently — when someone buys this type of insurance, they’re making sure that any large loans they owe money on will die with them. By using this kind of policy to pay your lender, you can make sure your heirs inherit whatever assets you bought in life without inheriting your loans.
What does credit life insurance cover?
Credit life insurance covers large amounts of debt, like auto loans or mortgage loans. Considering it’s more costly than term life insurance, it makes sense to only buy this type of coverage if you have high outstanding debt.
Where do the premiums go?
Usually, the borrower (the policyholder) pays a regular premium, just like they would with a normal insurance policy. Often, policyholders have the option of rolling their premium payments into their monthly loan payments. If the debt is not paid back during the borrower’s lifetime, the premium payments they made are used after their death to pay back the balance.
How does your loan balance affect your policy?
Your policy term corresponds with your loan’s maturity. In other words, the length of your policy term correlates to how much of your loan is paid off when you buy the policy (and how long you expect it will take to pay it off completely).
The amount you put toward paying off your loan each month also affects your term length. Contributing a higher amount shortens your term and vice versa. Then, once the borrower dies, their heirs do not have to pay off the remaining loan balance.
How does the death benefit work?
With a credit life insurance policy, your death benefit, or payout, decreases as your debt decreases. Basically, as the borrower/policyholder pays back their loan during life, a smaller payout is needed when they die to pay back the leftover balance. As the loan balance gets smaller, so does the payout.
Just remember, the monetary payout goes to the lender, not the borrower’s heirs. This is how heirs are able to retain the assets with a clear title.
Where can you get credit life insurance?
Generally, you should be able to purchase a credit life insurance policy from a bank, at a mortgage closing, when you take out a line of credit, or upon taking out a big loan. If you find yourself in any of these situations, check with your financial advisor to see if you should purchase a policy.
Do you or your heirs have to pay taxes on the payout?
No. The payout from a credit life insurance policy is not taxable. Recall that the proceeds of the policy go toward paying off your debt, making the lender the beneficiary of your policy. Since the lender is the beneficiary, and the benefit is a repaid loan, there is no estate or inheritance tax on the payout.
In short, your heirs will not be required to pay taxes on your death benefit for this type of policy.
Who should get a policy?
You should consider buying credit life insurance if you have a cosigner on a large loan, such as an auto loan, or if your dependents are reliant on the asset(s). For example, if your children live in the house you bought with a mortgage loan, taking out this type of policy will ensure that the bank does not repossess the home upon your death.
Credit life insurance is essentially a debt repayment plan. So if you want to pay for coverage that simultaneously helps pay off your debt, this type of policy makes perfect sense for you.
Lastly, if you cannot get a normal life insurance policy because a medical exam prevents it but you want to make sure your debts are paid off when you die, this insurance is ideal. Credit life insurance policies do not require a medical exam, so they’re widely accessible.
Pros and cons of credit life insurance
Let’s look at the pros and cons of credit life insurance so you can decide if it’s right for you.
Here is a list of the benefits and drawbacks to consider.
- Policies do not require medical exams and are generally easy to get.
- There is no age limit.
- Policies are voluntary and not required by lenders.
- Insurance is limited to debt repayment with no additional benefits.
- There is no flexibility once you purchase a policy.
- Other types of life insurance may be a better fit, depending on your financial situation.
Credit life insurance policies are relatively easy to get since they encourage people to pay back their debts. If there were lots of hoops to jump through, borrowers would be less inclined to buy these policies and would risk saddling their heirs with debt. Additionally, there is no set age limit for taking out one of these policies. You can buy this coverage at any time to help pay off your debts after death.
As mentioned above, there is a much less stringent health screening/exam process to get approved for a policy. This is because what’s being insured is the debt on your loans and assets, not your life. Since getting a credit life insurance plan isn’t contingent on your medical history or good health, it’s a very accessible policy option.
These policies are always voluntary, and you cannot be required by a lender to have one to secure a loan.
Though credit life insurance may be the best choice for some people, it has certain drawbacks that everyone should consider before opting in.
First, this type of policy has limited coverage. Since it’s not a regular life insurance policy, but is more like a debt repayment plan, it only extends as far as the policyholder’s outstanding debts at the time of their death. This means that the cost of living, tuition, lost income, and other expenses typically covered by life insurance aren’t included.
Another disadvantage is the limited flexibility of these plans. You cannot modify this type of policy once it’s in place. So if the needs of the policyholder change, there aren’t many options explains Jeff Mains, CEO of Champion Leadership Group.
“If the policyholder’s debt load changes, or if they acquire new financial obligations, they may not have adequate coverage under their existing policy,” he says. “In contrast, other life insurance policies offer greater flexibility, as policyholders can adjust their coverage levels and beneficiaries as their needs change over time. This can provide individuals with more peace of mind and a greater sense of security, knowing that they have the flexibility to adapt their coverage as their life circumstances evolve.”
How much does credit life insurance cost?
Credit life insurance premiums mainly depend on your loan amount. Your payments will also be higher if you decide to roll your premium payment in with your monthly loan payment because it increases the interest you owe.
It’s also important to remember that these policies are typically more expensive than term life insurance policies. Credit life insurance costs more because, without a medical exam, there is a greater risk associated with insuring you and the asset.
Other factors that can affect how much you pay include the type of credit you’re paying off, the details of the policy you purchase, and the amount of debt you owe. Basically, the price of these policies can vary drastically based on the details of your financial situation. Talk to your financial advisor or insurance company to get a clearer idea of how much you can expect to pay for this kind of policy.
Alternative policy: Term life insurance
Of course, credit life insurance isn’t your only option when it comes to life insurance coverage. Conventional term life insurance can also protect heirs from taking on your debt when you die. But unlike credit life insurance, the payout goes to your heirs instead of the lender. Your beneficiary is then free to use the money from your policy to pay off your debts as needed.
Though term life insurance is more affordable than credit life insurance, it does not guarantee your debts will be paid off when you die. It’s also often contingent on a medical exam but is overall less expensive than credit life insurance. If a medical exam does not preclude you from a term life insurance policy, consider this option before you consider a credit life insurance policy.
Lastly, with a term life insurance policy, the policyholder’s beneficiaries receive the payout tax-free. This is similar to the tax-free payout of a credit life insurance policy. But instead of the payout going to a lender, the payout from a term life insurance policy goes to the insured’s heirs.
Compare life insurance options
If you’re ready to shop around for a life insurance policy, check out our list of the best term life insurance companies and our breakdown of which type of life insurance is the best for you. You can also read reviews and compare your options for life insurance policies.
- Credit life insurance protects your heirs from inheriting your outstanding debt.
- Your premiums go toward your loan payments to help reduce the amount you owe.
- Your payout goes to your lender, not your heirs. This ensures that your heirs can take your assets and other personal property with a clear title when you die.
- How much your policy costs depends on the amount of debt you owe.
- If you need more flexibility, a traditional term life insurance policy may be a better fit.
View Article Sources
- What Is Credit Life Insurance? — Office of the Comptroller of the Currency
- Credit Insurance – Do You Really Need It? — Office of the Insurance Commissioner Washington State
- What Are The Different Types of Life Insurance? — SuperMoney
- What Does Life Insurance Cover? — SuperMoney
- I Need Life Insurance. What Kind of Life Insurance Should I Buy? — SuperMoney
- The Differences Between Whole and Term Life Insurance — SuperMoney
- Can You Use Life Insurance While You’re Still Alive? — SuperMoney