Credit insurance: What is it and do you need it?

Credit insurance is designed to offer you protection from missed payments on a loan in the event you become unemployed or disabled, or if you die unexpectedly. But this extra coverage can be expensive and unnecessary — so it’s important to weigh your options carefully.

Credit insurance may be available on all sorts of loans, including home mortgages, personal loans, credit cards, auto loans, and loans for furniture or appliances.

But even though this coverage can protect you if you have cash flow issues in the future, it may be more expensive than a life or disability insurance policy — both of which could actually give you more protection for events that may leave you at risk of nonpayment on your loan.

Let’s take a look at whether credit insurance ever makes sense and, if so, what you need to know when you’re shopping for it.

• How does credit insurance work?
• When does it make sense to consider credit insurance?
• Types of credit insurance
• How much does credit insurance cost?
• Things to consider before buying credit insurance

How does credit insurance work?

Credit insurance covers your loan payments if you become unable to make those payments yourself for the reasons outlined in your specific policy. You can generally purchase a credit insurance policy directly from your lender when you get your loan. The lender may market this type of policy to you when you’re taking on your new loan, but it typically can’t require you to purchase credit insurance.

And take note that your lender must make clear what’s being offered to you — the Federal Trade Commission, or FTC, says it’s illegal for a lender to deceptively include credit insurance in your loan without your permission or knowledge.

When does it make sense to consider credit insurance?

The short answer is almost never. Because credit insurance is optional and can add extra costs to your loan, it may make your loan less affordable, putting you at greater risk of default. And if you already have life insurance or disability insurance of any kind, your coverage probably costs less than if you switched to credit insurance.

Still, there are some instances when you might want to consider this type of insurance (for example, if you have loans that you can’t defer or put into forbearance, or if you’re worried about debt after death).

Before you consider credit insurance, it’s a good idea to ask your lender about any hardship programs it might have to help if you lose your job or can’t continue making your scheduled payments. Things like debt forgiveness or debt settlement may also be options.

Types of credit insurance

There are four main types of credit insurance:

1. Credit disability insurance: Makes payments to your lender if you become injured or sick and can’t work. It’s also called “accident and health insurance.”
2. Involuntary unemployment insurance: Makes payments to your lender if you’re laid off or otherwise lose your job through no fault of your own. It’s also called involuntary loss of income insurance.
3. Credit property insurance: Provides coverage for personal property that was acting as collateral for the loan if it’s destroyed by an accident, theft or natural disaster.
4. Credit life insurance: May pay off some or all of your remaining loan balance to your lender if you pass away.

How much does credit insurance cost?

Credit insurance can be more expensive than other types of insurance. According to the State of Wisconsin Department of Financial Institutions, the annual cost for credit life insurance for a 30-year-old in good health is approximately $370 for $50,000 of coverage, compared to $78 for term life insurance. That’s nearly five times the cost — probably not something that makes financial sense.

Credit insurance premium costs can vary widely though, because they may be determined by a number of different factors, such as …

• The type of loan or credit you’re getting
• The amount of debt that will be protected
• The type of credit insurance policy you choose

Your insurance costs and the way you’re charged for coverage may also depend on whether your debt is open- or closed-end.

Open- vs. closed-end credit

Open-end credit (also known as revolving credit) allows you to borrow more at any time, up to your credit limit, often with a credit card. There’s no fixed repayment schedule to pay back the balance in full, although there’s usually a monthly minimum payment amount.

The monthly insurance cost will be part of your minimum monthly payment and should be displayed separately on your loan or credit card statement.

Closed-end loans are repaid over a fixed timeline, in which you’re required to have paid off your entire balance. Installment loans, like most auto and personal loans, that are repaid on a monthly basis are common examples of closed-end loans.

With closed-end loans, the cost of your credit insurance may be included as a monthly premium or single premium option.

Things to consider before buying credit insurance

If you’re considering credit insurance, here are a couple of things to keep in mind:

Shop around and think about other types of insurance

If you don’t already have other insurance that covers debt, compare the cost of credit insurance to that of other types of insurance. It may be less expensive to get another type of insurance that may pay you or your family, versus your lender, if something were to happen.

Some policies have restrictions

Before you sign on the dotted line, make sure you understand all the details of the credit insurance policy being offered. Some policies have waiting periods or exclusions. For example, with certain credit disability insurance policies, if you file a claim within the first six months of the policy because of a health condition you were treated for up to six months before you got the credit insurance, your claim could be denied.

What’s next?

While credit insurance may seem like a smart purchase at first, it can add significant costs to your loan. If you decide to buy it, make sure you fully understand the policy terms and any limitations. Here are a few questions the FTC suggests you ask credit insurers if you decide to get credit insurance.

• How much is the premium?
• Will the premium be financed as part of the loan?
• Can I pay the cost of credit insurance monthly instead of financing the full premium as part of the initial loan?
• What’s covered under the policy and what isn’t?
• Can I cancel the insurance and, if so, will I receive a refund?
• Will the full loan amount be covered until the loan is paid off?
• Is a co-signer covered, and is there an additional cost for their coverage if I add one?

If you have reservations about credit insurance, you may want to consider setting aside the money you’d pay for coverage into an emergency fund instead. This will give you a way to build savings to use toward unexpected expenses without adding a monthly cost to your loan.