Myth: You Need Credit Insurance

The Word on the Street

Whenever someone wishes to make a large purchase on credit (like a house or a car), the lender will often try to sell them an insurance policy. These policies are supposed to protect your family from having to repay the loan in case the buyer dies.

The Truth

This insurance does not truly protect you or your family. Why do you think they press the issue so hard? Is the car salesman or the dealership really out there to do you favors? No. They are out there to make a profit. And there’s nothing wrong with that. But, as a consumer, you ought to be aware that credit insurance really only benefits the lender. When you buy credit insurance, you are in fact guarantying your lender that it’s loan will be repaid. You are paying their insurance premium!

What is Credit Insurance?

The insurance that the salesman/banker will try to sell you is a type of insurance called credit insurance, although they may not call it that. What credit insurance does is pay off the remaining balance of your loan if you should die. If the loan is sufficiently large (like in a mortgage) and you meet certain criteria, a lender may require you to purchase this insurance before they will issue the loan. This is a typical arrangement for mortgages where the buyer has only a small down payment. When it comes to auto loans, these policies are usually discretionary, and will often be paid for with one large premium payment at the time of purchase. This post focuses on discretionary insurance for auto loans, rather than potentially mandatory insurance for mortgages.

How They Sell It

When making a large purchase, people have a tendency to downplay the magnitude of some costs. They figure, “I’m already paying $20,000, what’s another $400 more?” By exploiting this tendency, car salesmen are often able to convince the buyer that the cost of the insurance is a small price to pay. They bury the cost within the larger cost of the car and make it seem as though it is a good deal.

This next tactic is downright cruel. What the salesman will tell you is that this insurance will protect your family from having to pay off the loan should you die. He tries to convince you that your family will be left financially bereft by having to continue to make the car payment. By playing on the emotional bonds within your family, he impairs your rational judgment within a cloud of powerful emotions. This is how they convince you that this insurance is a good deal, and will benefit your family.

Don’t Fall For It

It’s true that your family will receive the money to pay off the loan, and that will benefit them. It’s also true that you ought to use life insurance to help pay off your debts so your family can be free of them should you die. So why shouldn’t you get the credit insurance?

Short Answer

It’s way over priced!

Long Answer

An example. Suppose Herb buys a $20,000 car, taking out a $15,000 loan for 4 years. The dealer offers credit insurance to cover the loan in case he dies. The policy is available for an up-front cost of $500, which they offer to include with his loan. Is this insurance a good deal? Assuming Herb is 35 years old and in good health, for $125 per year over a 4-year period, Herb could purchase a traditional level term life policy for at least $100,000 coverage. So, for $500, he could have $15,000 of declining life insurance (to cover the car loan) for 4 years, or for $500 ($125/year for 4 years) he could have $100,000 of coverage that he could keep that his family could use any way they wish, should he die. Dollar for dollar, the credit life insurance is much more expensive. If you are considering buying a car and wish to cover the loan in case you die, you would be much better off purchasing traditional, term life insurance than you would to buy the credit insurance the dealer may offer you.

Posted on 11 May 2009