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How credit insurance works on a loan
Though it protects your credit score from taking a hit, it can get pricey.
It’s hard to predict what will happen after you take out a loan. If an accident or unexpected job loss pushes you into defaulting on your payments, it can seriously damage your credit and finances. Credit insurance is designed to prevent the worst-case scenario if you find yourself unable to repay your loan. But it can be expensive and, ultimately, may not be worth the cost.
What is credit insurance?
Credit insurance is a type of insurance that covers your repayments if you can’t make them due to unforeseen circumstances. You might also see lenders refer to it as payment protection or payment protection insurance. It can prevent default and damage to your credit score if you become disabled or unemployed before your loan is fully paid off, and it typically lasts the life of your loan.
Your lender might suggest credit insurance if you have less-than-perfect credit and are looking for a car loan, auto equity loan, mortgage or unsecured personal loan. It’s also often suggested to borrowers ages 65 and older.
Do I have to buy credit insurance if my lender suggests it?
No, it’s illegal for a lender to force you to buy credit insurance, according to the Federal Trade Commission (FTC). If a lender is pressuring you to buy it, report them to your state attorney general, state insurance commissioner or the FTC.
5 types of credit insurance
There are five common types of credit insurance you might come across, though many lenders bundle them together:
- Credit life. Covers loan repayments if you die before fully repaying your loan.
- Credit disability. Covers some but not all of your repayments if you’re injured while paying off your loan. Also called credit health or accident insurance.
- Credit involuntary unemployment. Covers some of your repayments if you’re laid off or become unemployed for a reason that’s not your fault.
- Credit family leave. Covers a few monthly repayments if you need to stop working to take care of a newborn or sick family member. Also called credit leave of absence insurance.
- Credit property. Covers the personal property you use to secure a loan if that item is stolen or damaged. It’s most common with financing offered by furniture or jewelry stores.
How much does credit insurance cost?
The cost of credit insurance depends on personal details and your loan, including:
- Where you live. Different states enforce different regulations that limit how much your lender can charge you. States with looser regulations will likely allow higher premiums.
- Loan amount. Typically, the more you borrow, the more you’ll pay each month for insurance.
- Loan term. Longer terms are typically more expensive that shorter terms.
- Insurance type. Different types of insurance require with different amounts of coverage, which can affect the price. For example, credit life insurance covers all repayments if you die, while family leave covers only a few repayments while you’re not working.
8 questions to ask before getting credit insurance
The Federal Trade Commission and other consumer watchdog groups warn that credit insurance isn’t always necessary. Ask yourself the following questions to learn whether you or your situation could benefit from credit insurance:
- Do I already have life or disability insurance? If you do, chances are good that your insurance policy covers loan repayments after an injury or death.
- How does the cost compare to traditional insurance? If you don’t yet have life or disability insurance, getting policy quotes from insurance providers first can shed light on whether your lender’s offer is a competitive deal.
- Can I afford it? Credit insurance increases the cost of your loan, sometimes significantly. Make sure that your budget can absorb it.
- How does the premium work? Is the premium added to your entire loan amount — which means you’ll pay interest on it — or is it something you pay separately each month?
- What does it cover? Carefully read the fine print to make sure you understand what’s covered under specific circumstances.
- Can I cancel my policy? Ask whether you can cancel coverage within your loan’s terms — and, if so, whether you’d qualify for a refund.
- When does coverage go into effect? Some credit insurance policies require a waiting periods, meaning your insurer might not pay out your benefit immediately.
- Is my cosigner covered? If someone else is also signing your loan, ask if they’re covered and to what extent.
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3 things to know before signing up for credit insurance
Credit insurance isn’t always a helpful addition to your loan — especially if it makes your loan more expensive than you can afford. When considering this protection, know that:
- It’s never required. It’s illegal for lenders to require you to buy credit insurance — though some strongly recommend it. If a lender says you must purchase credit insurance to get a loan, look elsewhere.
- It’s not included in the APR. Sometimes lenders push credit insurance on low-credit borrowers to increase the cost of the loan without having to increase the APR.
- It can increase your loan amount. Some lenders add your credit insurance premium to your loan balance, meaning you’ll pay more in interest over time. This can lead to higher monthly repayments, which you might not be able to afford.
Read the fine print
An untrustworthy lender might try to sneak credit insurance into the terms and conditions of your loan. It’s another reason to carefully read your loan contract before you sign it.
If you notice terms that sound like they’re referring to something like credit insurance, ask your lender. The FTC recommends that you find another provider if yours tries to pressure you into buying credit insurance.
Credit insurance alternatives
Not sure whether credit insurance is right for you? Consider one of these options instead:
- Traditional insurance. Disability or life insurance is often less expensive than credit insurance. It also might cover more situations, and you’ll never pay interest on it. Plus, the payouts from these insurance plans can often be larger than those that come with credit insurance.
- Help from friends and family. Talk to your loved ones to come up with a plan for how to handle personal expenses, including loan repayments, should something happen to you. They may be willing to pitch in.
- An emergency fund. By putting funds aside for an emergency, you’re in a better position to cover an unexpected change in your finances, eliminating the need for credit insurance in the future. If you don’t have an emergency fund, get started with a high-interest savings account that can accelerate the growth of your savings.
Credit insurance might protect your credit score from the effects of default if you’re unexpectedly unable to pay off your loan. But it’s often more expensive than life or disability insurance, and it can significantly increase the cost of your loan. Before signing up, look into the cost of a traditional insurance plan or setting up an emergency fund that can cover you in the future.
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