What is credit insurance on a loan?

Types of personal loan credit insurance

There are four primary types of personal loan credit insurance, and the one that’s right for your needs depends on how you’re using your loan and the coverage you need.

• Credit life insurance: This type of credit insurance will kick in if you die before your loan is paid back. It’s similar to life insurance, but the policy will cover a specific debt first. If the payout amount is higher than the debt owed at the time of your passing, the additional funds will go to your estate.
• Credit disability insurance: This type of insurance will cover your debts in case of an unexpected disability. Insurers usually won’t cover preexisting conditions, so there’s usually a waiting period for coverage.
• Credit involuntary unemployment insurance: This insurance will cover your debt if you become unemployed during the loan term and can no longer make your monthly payment.
• Credit property insurance: This covers damage or loss to personal property used as collateral for a loan, such as financed furniture or appliances. Credit property insurance usually doesn’t apply to larger purchases, like automobiles or homes.

There are some eligibility requirements for the different types of coverage. For example, credit disability and unemployment insurance usually require active employment at the time of enrollment, and credit life insurance often has a maximum age for eligibility. All forms of coverage can come with waiting periods and may exclude preexisting conditions.

How personal loan credit insurance works

Credit insurance for personal loans or personal lines of credit protects you and your lender in case you become unable to pay back your loan as a result of a specific covered event. For example, if you have credit life insurance, the policy will pay back your lender if you die rather than making your next of kin or your estate responsible for the payments.

Unlike traditional insurance, your lender will always receive the insurance payouts first. If there’s an excess of funds, you or your estate may receive the additional funds, but those payouts are always secondary to paying back your lender.

Most policies come with additional terms and conditions, including age restrictions, waiting periods before coverage can kick in and coverage limits for the total payout. Some policies have other exclusions, like unemployment insurance not taking effect if you quit voluntarily or disability insurance for preexisting conditions.

Costs and considerations of personal loan credit insurance

The cost of your personal loan credit insurance depends on the type of policy you take out, the balance of the account and the type of loan for which you need coverage. Generally speaking, the larger the amount of credit you want covered, the higher your credit insurance will be since your insurer is taking on more risk.

Personal loan credit insurance can get expensive, and in most cases, your personal loan credit insurance premium will be included in your principal. That means you’ll pay interest on the premium, which drives up all-in coverage costs even further. Get estimates for insurance premiums and calculate long-term costs based on your APR before agreeing to coverage.

You should think carefully about whether or not personal loan credit insurance is worth the investment. It can provide financial protection for debts you may not be able to cover in certain circumstances, but the cost of the insurance may not make the coverage worthwhile.

If you already have life insurance or a cosigner who could cover payments, it may be better to forgo credit insurance to save money long-term.

» COMPARE: Top personal loan lenders

Pros and cons of personal loan credit insurance

Personal loan credit insurance can be beneficial in certain circumstances, like if you don’t have another form of protection, like life insurance, to cover potential crises. The cost of coverage can also be relatively low and worthwhile if you’re able to pay for the insurance coverage up front rather than paying interest on the premium.

Here are some pros and cons to consider before you opt into coverage:

Pros

• Credit score protection: If you become unable to make your monthly payments, personal loan credit insurance can cover your debts and prevent major hits from defaults on your credit report.
• Peace of mind: Credit insurance always provides some assurance because it guarantees your debts will be covered if some unexpected circumstance affects your ability to repay your debts.
• Potential for low up-front cost: Most credit insurance providers will add your premium to your loan amount. While this means higher costs over time due to interest, it also means policies can be very affordable up front.
• Can protect your family or estate: If you’re concerned about your debts becoming a burden to your family members, personal loan credit insurance can kick in to make payments instead.

Cons

• Increased loan costs: Whether you pay the insurance premium up-front or add it to your principal, you’ll pay more for your loan over time as a result. Adding the premium to your principal will lead to a significant increase in cost since you’ll also pay interest on that amount.
• Potential redundancy with other policies: Personal loan credit insurance may overlap with existing policies, like a personal life insurance policy. In some cases, you may not get the full benefit from your personal loan credit insurance if there are other policies covering your specific covered event.
• No personal gain: Personal loan credit insurance policies primarily make payouts to your lender, so in the event of unemployment or disability, you won’t see any payouts that can help reduce personal financial strain.
• Coverage restrictions: Personal loan credit insurance comes with restrictions, which may leave you without the necessary coverage in certain circumstances. For example, you’re unlikely to get coverage if you take out insurance after you become unemployed or experience a disability.
• Could be unnecessary: In many states, personal debts don’t pass to your spouse or family, so getting personal loan credit life insurance may not be necessary. Check if you live in a community property state first. If you don’t, you may not need credit life insurance.

Alternatives to personal loan credit insurance

Personal loan credit insurance is always optional, and while it might be beneficial in some cases, there are some alternatives you should consider that could provide greater protection and fewer restrictions on payouts.

• Emergency funds and savings: The simplest alternative to personal loan credit insurance is just to have savings set aside for emergencies. Speak with a financial planner to get an idea of how much you should have in your account to cover hardships.
• Life and disability insurance policies: Life insurance may provide enough of a payout to your family members to cover your personal debts in the event of your passing in a community property state, and disability insurance could provide personal protection if you become disabled and can no longer work.
• Unemployment benefits: Personal loan unemployment insurance may not be necessary if you can instead take unemployment benefits from the state. Coverage amounts vary based on your previous income and other factors, though, so payouts may not be sufficient to cover your living expenses.
• Lender hardship programs: Some lenders offer hardship programs that can help reduce your monthly payments in the event of a qualifying hardship, like unemployment or disability. This isn’t always available, and benefits and restrictions vary widely.

» MORE: Trusted loan modification lenders