Credit Life Insurance
Credit life insurance is an insurance policy that promises to pay off a specific loan if you should pass away with outstanding debt.
How does credit life insurance work?
Credit life insurance is a policy that protects a lender by insuring that, if the borrower dies, a loan will be paid off.
When you take out a large loan, such as a mortgage, auto loan, or business loan, you have the option of signing up for credit life insurance. If you should die while there is still a balance owed, the insurance pays off the remainder of the loan.
This is a very different kind of life insurance policy from traditional ones, in that should you pass away, the insurance company pays the lender, not your loved ones. With a typical life insurance policy, the payout would go to beneficiaries like your spouse or children. With credit life, the payout would go to whatever entity gave you a certain loan you haven’t finished paying off at the time of your death.
Once you take out a credit life insurance policy, in addition to the monthly loan payment, you make payments (called ‘premiums’) on the insurance policy. In return, if you should die with outstanding debt, the insurance kicks in, and the policy pays the lender the remaining loan amount. Some policyholders take out credit life insurance against credit card debt or other kinds of debt as well.
The idea is that the policyholder protects anyone who signs the loan along with them (the ‘co-signer’) from having to make the payments if the policyholder should die before paying off the loan. In that case, the payout, or death benefit, goes to the lender. The policyholder’s spouse or other co-signor (business partner, for example) isn’t stuck making the payments.
Is credit life insurance worth it?
We can’t make that decision for you. But you’ll typically pay much more for credit life insurance than traditional life insurance that would have a similar payout. Why is that?
That’s because pretty much anyone who applies for credit life insurance is going to be approved (it’s a ‘guaranteed issue’ policy, in insurance lingo). You don’t have to go through a medical exam or even a medical questionnaire to get credit life insurance, so the life insurance company, not knowing whether you’re a high risk or low risk, charges you as if you were a high risk of passing away before paying much into the policy. Especially if you’re in good health, another type of life insurance is probably a better bet.
Why would I sign up for credit life insurance?
You would take out such a policy to protect your co-signer, who is effectively another borrower on the loan and would otherwise be responsible for the payments if you should die.
If you live in one of the nine states that’s called a community property state, any assets or debts that you hold are also the responsibility of your spouse, whether they co-signed the loan or not. Credit life insurance would protect them from having to make the loan payments. (Those states are Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin.)
If you’re hoping to protect your heirs and their credit rating, remember that they generally don’t inherit your debt. (Here’s a good explainer with more info on that point.) Lenders know they take a risk when they loan money, and sometimes borrowers don’t pay it back.
Would I ever be required to get credit life insurance?
No. Lenders can’t deny you a loan based solely on your refusal to sign up for credit life insurance.
Remember, credit life insurance protects the lender, and you may not need it in order to protect your heirs or other family members.
What are some alternatives to credit life insurance?
Traditional life insurance policies are often cheaper, and can serve the same purpose. Your loved ones could still use the payout to pay off any remaining debt, or they could use the money to pay for more pressing costs.
There are two main types of life insurance you could take out instead of credit life insurance: term life insurance and permanent life insurance.
Term life insurance covers a specific period of time (the ‘term’), like ten, twenty, or thirty years. As long as you make payments to your insurer, should you pass away during that period, the insurance company issues the payout to a person of your choosing (the ‘beneficiary’).
Term life insurance policies can be less expensive than credit life insurance, because you’ll either undergo a medical exam or, in the case of a no-exam policy like Lemonade offers, answer medical-related questions online so that the insurer can assess your risk.
If you’re approved for a term life insurance policy, you might pay lower premiums for a bigger death benefit than you would with credit life, since the insurer has already assessed your risk. And remember, the death benefit doesn’t change once you sign the policy, whereas with credit life insurance, the more you pay the debt down, the smaller the face value of the policy. That makes it the rare insurance policy that has a smaller and smaller benefit the more you pay.
There is also permanent life insurance, which include ‘whole life’ insurance policies. These (essentially) guarantee a payout when you pass away, whether in five years or in fifty years. In return for that security, whole life insurance can be considerably more expensive than term life insurance; the same person might pay a premium anywhere from five to fifteen times higher than they would pay for term life insurance.
Permanent life plans do have other advantages, including that the insurance company invests a part of the premiums you pay in a tax-deferred cash value component that bears interest at a rate determined by the insurer, so your policy builds cash value over time. The cash value component of whole life has a few pluses, like for example, you can borrow against the cash value of your policy should you need to. To learn more, check out our deep dive into the topic.