What Is a Frequent Cost of Credit Life Insurance Coverage?
Demystify the cost of credit life insurance. Understand premium calculations, influencing factors, and the full financial impact of coverage.
Credit life insurance is a specialized type of coverage designed to pay off a specific debt if the borrower dies before the loan is fully repaid. This insurance differs from traditional life insurance because the lender, rather than a family member, is typically the sole beneficiary of the policy. The policy aims to ensure that outstanding debts like mortgages, auto loans, or personal loans are settled, preventing the financial burden from falling on surviving family members.
How Credit Life Insurance Premiums are Calculated
Credit life insurance premiums are calculated using two methods: a single premium or a monthly premium. The single premium method involves calculating the entire insurance cost upfront. This lump sum premium is often added directly to the principal of the loan, increasing the total amount borrowed. As a result, the borrower pays interest on both the original loan amount and the financed insurance premium over the loan’s term.
The monthly premium method involves ongoing payments that are calculated based on the outstanding loan balance. This approach is frequently used for revolving lines of credit, such as credit cards or home equity loans, where the debt amount can fluctuate. Under this method, the premium amount adjusts monthly, decreasing as the loan balance is paid down. This provides a more direct reflection of the diminishing coverage needed for the outstanding debt.
Factors Affecting Your Premium
The initial loan amount is a factor, as a larger loan means a higher insurance cost due to the increased potential payout required to cover the debt. The length of the loan term also affects the premium, with longer terms resulting in higher overall costs for the insurance coverage. This is because the insurance is in force for an extended period.
The specific type of loan being insured, whether it is a mortgage or an auto loan, can also determine the premium rate. Many credit life insurance policies feature decreasing term coverage, meaning the death benefit automatically reduces as the loan balance declines over time. While health status is a consideration for traditional life insurance, many credit life insurance policies are “guaranteed issue,” meaning they do not require a medical exam. This accessibility can lead to higher premiums compared to policies that involve medical underwriting.
Other Financial Aspects of the Cost
When a single premium is financed into the loan, borrowers pay interest on that insurance cost for the entire duration of the loan. This can increase the total amount paid for the insurance over time, making the actual cost higher than the stated premium. For example, a credit life insurance premium could add 1% to 5% to a monthly loan payment, further increasing borrowing costs.
Borrowers may be entitled to a refund of unearned premiums if the loan is paid off early, such as through refinancing or a lump-sum payment. The amount of this refund depends on the remaining term of the policy and how much of the premium was financed. However, if the policy is canceled without the loan being fully repaid, a refund of premiums should not be expected. A refund can partially offset the initial cost, but it is not guaranteed unless tied to a loan payoff event.