Introduction 

Credit insurance is a form of insurance policy bought by a borrower which pays off one or more existing debts in case of the borrower’s death, disability, or in rare cases, unemployment. Credit insurance often comes as a credit card feature, with the monthly cost charging a low percentage of the card's unpaid balance. 

Credit insurance can be a financial backup in the event of certain catastrophes. A lot of credit insurance policies are overpriced as compared to their benefits, as well as loaded with fine print that can make it hard to collect. Hence, borrowers must read the fine print carefully before buying credit insurance.

Types of Credit Insurance

There are generally five types of credit insurance. Four of these are designed for consumer credit products and the fifth type is for businesses.

1. Credit life insurance – This type pays off your credit card balance in the event of your death. This keeps your loved ones from having to pay your outstanding credit card balance out of your estate or worse, out of their pocket.

2. Credit disability insurance – This credit insurance pays your minimum payment directly to your credit card issuer if you become disabled. You may have to be disabled for a certain amount of time before the insurance pays out. There may be a waiting period before the benefit kicks in. So, you can’t add the insurance policy and make a claim the same day.

3. Credit unemployment insurance – This insurance pays your minimum payment if you lose your job through no fault of your own. If you quit, for example, the insurance benefit doesn’t kick in. In some cases, you may have to be unemployed for a certain amount of time before the insurance pays your minimum payment.

4. Credit property insurance – It protects any personal property you’ve used to secure a loan if that property is destroyed or lost in theft, accident, or a natural disaster.

5. Trade credit insurance – This is a type of insurance that protects businesses that sell goods and services on credit. It protects against the risk of clients who don’t pay because of insolvency and a few other events. Most consumers won’t need this type of insurance.

Important Questions to Consider Before Purchasing Credit Insurance

• Do you have other insurance or assets that would cover debt obligations in the event of your death, disability, or unemployment?

• Would it be better to buy a life insurance policy or a disability insurance policy? Credit insurance may cost more than other more traditional insurance options.

• If you purchase single premium coverage, will the premium be financed as part of the loan? If so, how much will the loan payment increase due to the cost of the credit insurance?

• Will the credit insurance cover the full term of the loan and the entire balance?

• How long is the waiting period for the monthly benefit to be paid?

• What isn't covered by the policy?

• Can the insurance company or lender cancel the insurance?

• Can policy terms or premiums be changed without consent?

Cost of a Credit Insurance policy?

The cost of a Credit Insurance policy depends on multiple factors such as the loan amount/ debt amount, type of credit and the type of policy. The premiums can be paid either in a Single payment method or through the Monthly Outstanding Balance method.

• Monthly Outstanding Balance method- This method is one of the most common options with credit cards, home equity loans and similar other debts. There are two categories under this mode of payment.

  • Open-end accounts - The premium is charged monthly and is based on the monthly debt. The amount will be stated as a separate charge on the statement sent out by the lender. 

  • Closed-end accounts - The amount of debt does not vary and a fixed amount has to be paid every month. Failure to pay this amount will result in cancellation of the policy.

• Single Payment method- Under this method, the premium amount is calculated at the time of initiation of the policy and the borrower will be responsible for the entire payment at the time the policy is purchased.

Open v/s Closed-End Credit

Open-end credit (also known as revolving credit) allows you to borrow more at any time, up to your credit limit, often with a credit card. There’s no fixed repayment schedule to pay back the balance in full, although there is usually a monthly minimum payment amount. With open-end credit, the cost of credit insurance may be charged via the monthly premium method. This means that the credit insurance premium each month is calculated every month — either by the average daily balance or the balance at the end of the month. Your policy will specify which calculation method is used. The monthly insurance cost will be part of your minimum monthly payment. This charge should be displayed separately on your loan or credit card statement.

Closed-end loans are repaid over a fixed timeline, in which you are required to have paid off your entire balance. Instalment loans, like most auto and personal loans, that are repaid every month are common examples of closed-end loans. With closed-end loans, the cost of your credit insurance may be included as a monthly premium or single premium option. With a single premium, the insurance cost is set at the beginning of the loan and added to the amount you originally borrow, increasing both the amount borrowed and the amount of interest you’ll pay. If calculated as a monthly premium, then the outstanding balance in the account on the monthly billing date is multiplied by the premium rate.

FAQs

1. What are the main benefits of credit insurance?

Credit insurance protects against unforeseeable bad debts and allows you to grow your business or sustainably continue your activities.

2. Is credit insurance mandatory for a loan?

Credit insurance is optional. But it always advisable to avail credit insurance with a loan to stay protected against loan liabilities.

3. How does the policy payout under Credit Life insurance?

in case of an unfortunate death of the insured, the policy pays out the outstanding loan amount to the creditor.

4. How is Credit Property insurance different from the other types of credit insurance?

Credit property insurance is not directly related to an event affecting the borrower’s ability to repay the debt.

5. How does this policy help business in improving its financial records or planning?

A credit insurance policy helps by ensuring that cash flow is maintained, profitability is increased, and budgets are protected. It also helps in improving credit decisions through informed decision-making by the policyholder.

End Note

If you’re considering credit insurance, it’s important to read the fine print of the benefits offered and when the insurance pays out. Always ask for a brochure or website that you can visit to learn more about the details of the insurance. Make sure you know the events that aren’t covered by the insurance and details on how you can cancel the insurance if it’s no longer needed.