Credit Life Insurance

What Is Credit Life Insurance?

Credit life insurance is a type of life insurance policy designed to pay off a borrower's outstanding debts if the borrower dies. The face value of a credit life insurance policy decreases proportionately with the outstanding loan amount as the loan is paid off over time, until both reach zero value.

How Credit Life Insurance Works

Credit life insurance is typically sold by banks at a mortgage closing; it could also be offered when you take out a car loan or a line of credit. The pitch is to protect your heirs if you die, since the policy will pay off the loan. If your spouse or someone else is a co-signer on your mortgage, credit life insurance would protect them from making loan payments after your death. This could be appealing if you are the primary breadwinner in your family, and the loan co-signer would be unable to make payments in the event of your death.

But in most cases, any heirs who are not co-signers on your loans are not obligated to pay off your loans when you die; debts are not generally inherited. The exceptions are the few states that recognize community property, but even then only a spouse could be liable for your debts — not your children. When banks loan money, part of their accepted risk is that the borrower could die before the loan is repaid. As such, credit life insurance really protects the lender, not your heirs. In fact, the payout on a credit life insurance policy goes straight to the lender, not to your heirs.

Credit Life Insurance Is Just One Way to Protect a Joint Borrower

If your goal is to protect a spouse from paying off your debts after you die, it could make more sense to purchase conventional term life insurance. In that case, when you die during the term of the policy, the value of the policy will be paid to your spouse, tax-free. They can then use some or all of the proceeds to pay off debt. Term coverage from a life insurance company is usually cheaper than credit life insurance for the same coverage amount.

Moreover, credit life insurance drops in value over the course of the policy, since it only covers the outstanding balance on the loan; the value of a term life insurance policy stays the same.

No Medical Exam Needed

One advantage of a credit life insurance policy is that it often requires less stringent health screening, and in many cases no medical exam at all. This is known as guaranteed issue life insurance. By contrast, term life insurance is almost always contingent on a medical exam; even if you are in good health, the premium price will be higher if you are older.

Credit Life Insurance Is Voluntary

It is against federal law to require credit life insurance in a loan, or to base loan decisions on the acceptance of credit life insurance. Nevertheless, credit life insurance is sometimes built into a loan, which makes your monthly payments higher, so it’s important to ask your lender about it.

The Bottom Line

Credit life insurance pays off a borrower's debts if the borrower dies. You can generally purchase it from a bank at a mortgage closing, when you take out a line of credit or get a car loan. This type of insurance is especially important if your spouse or someone else is a co-signer on the loan in order to protect them from having to repay the debt. It also protects your spouse or heirs in states where heirs aren't protected from a parent's outstanding debts.