We work hard to keep a solid financial footing. That’s why it can be so disheartening when life throws a curveball that ends up setting your hard-earned money and work off track. There are practical things you can do to build financial resilience. Many of these things, like saving an emergency fund and checking your credit report, are pretty mainstream and sage advice. However, there’s another important tip that often gets overlooked: having a backup plan for handling your debt obligations when the unexpected happens. One such backup plan is Credit Insurance, also called Creditor Insurance, Balance Protection Insurance, or Credit Protection Insurance. No matter the name, it acts as a safety net, saving you and your loved ones from financial distress at those times when you need the relief most.
What is credit insurance?
Credit insurance is a financial product tied directly to a specific loan, credit card, or other form of debt. Should something happen that prevents you from being able to repay the debt it’s tied to, the insurer will step in and help pay off all or a portion of the outstanding balance. Credit Insurance policies typically cover situations such as;
Life
A Credit Life Insurance policy will pay off all or a portion of the loan if the insured dies during the coverage term. The proceeds are paid directly to the creditor. If the insurance proceeds exceed the debt, the surplus is paid to the borrower’s estate.
Disability/ Critical illness
If the insured becomes disabled or diagnosed with a critical illness, a Credit Disability/Credit Health Insurance policy pays all or part of the monthly debt payment amount for a specified period of time. These policies typically require a waiting period (often 7, 14, or 30 days) before benefits begin, and the policy must clearly state whether it will retroactively pay for that waiting period.
Job loss
These policies pay all or part of the monthly bill if the insured becomes involuntarily unemployed due to a specified cause (such as a layoff or labour dispute). There is typically also a waiting period (often 30 days) required before benefits are paid out, and some policies are retroactive. Generally, these policies won’t pay out if you are fired with cause or resign from your job.
Collateral
These policies cover a piece of property that has been put up as collateral in order to secure a loan. Should the property be stolen or damaged, these policies will help partially or fully cover the debt it is tied to.
How does credit insurance work
Depending on the credit you are insuring and the insurer you decide to go with, your credit insurance policy may work a couple of different ways.
Premiums
The premiums for a credit policy are generally calculated in one of two ways.
The Single Premium method. This is when the total cost of the policy is added to the loan being borrowed.
The Outstanding Balance method. This method is a fluctuating calculation that is partially based on how much of an outstanding balance is left on the loan being insured. The primary calculation is based on several factors, such as:
- the amount of the loan
- the age, sex and health of the borrower
- the type of debt and policy
A premium rate is determined based on all these factors. That rate is then used each month to calculate that month’s premium. For example, based on the factors listed above, a borrower is given a premium rate of $1.50/$100. If they borrowed $1000, their premium for the first month would be $15 ($1000/$100 = 10, $1,50*10= $15). If they were to make a $100 payment on the loan, leaving a remaining balance of $900, their next month’s premium would then be $13.50 ($900/$100 = 9, $1.50*9 = $15).
Pay outs
There are also two ways credit insurance policy claims are paid out.
Life, critical illness, and collateral polices are generally paid out by a one lump sum payment. The amount of the payment will depend on the policy. Some policies will only cover the outstanding balance of the insured loan up to a certain amount. Other policies will pay out a specified amount and even give any remaining coverage to the insured or the insured’s estate.
Disability and job loss policies are typically paid out on a monthly basis for a specified period of time. These payments usually only cover minimum payment amounts to keep the loan up to date.
Who is credit insurance good for?
With the exception of those who don’t have any debt, credit insurance is something everyone should, at the very least, consider. It’s particularly good for those with families, so that everyone can live with the peace of mind that you have a safety net in place. Self-employed people who don’t have access to workplace benefits are another good candidate for credit insurance. Finally, business owners might want to strongly consider credit insurance to help protect the business and any employees they have working for them.
What to consider before signing on the dotted line
Before enrolling, take your time to review all the details of the policy carefully. Below are some important questions to ask yourself to ensure the policy is right for you.
- What are the coverage limits? For example, will the insurance cover the full length of your loan and the full loan amount? Does it only cover minimum payments?
- Does the value of having the insurance outweigh the cost to pay for it?
- Can you afford the cost of the policy?
- Are there any exclusions? What scenarios or issues (like a pre-existing medical condition) does the coverage not apply to?
- Are there any waiting periods to be aware of? If so, does the plan pay retroactively?
- How are payments handled? Is it a lump sum or monthly payments?
- Do you have other insurance that is sufficient to cover the debt? In other words, will taking this coverage mean being overinsured?
- What is the cancellation policy?
- Is the lender pressuring me to take the insurance, or even telling me it’s required? If so, it’s best to walk away. Mandatory credit insurance is illegal; it is always optional.
The key benefits of credit insurance
Choosing to purchase credit protection can be a crucial instrument for ensuring continuity and stability.
Financial stability and peace of mind
During an emergency, the last thing you want to worry about is paying bills. Creditor insurance ensures that your insured debt is either paid in full or that monthly payments are maintained for a period. This alleviates the worry of keeping your financial and credit health intact, allowing you and your family to focus on recovery.
Filling coverage gaps
Creditor insurance protects debt obligations against specific events, such as job loss, which can be difficult and expensive to purchase as a separate individual policy.
Protecting other assets
If you have existing life or health insurance, the proceeds from those policies might be intended for other crucial needs, like supporting your loved ones or funding education. When CPI pays off the debt, those other insurance proceeds remain available for their intended purpose.
Ease of access
This type of protection is often affordable and easy to obtain at the financial institution where you get your loan, line of credit, or credit card. Enrollment approval can often be immediate, sometimes requiring only a short ‘yes’ or ‘no’ health questionnaire. In fact, it’s rare for someone not to be approved for Credit Insurance. The main exception being a pre-existing health condition.
Supplemental support
Some credit insurance plans offer valuable assistance services, such as access to confidential psychological support, legal information, and convalescence assistance to help you recover from an illness or accident.
Wrap up
Creditor insurance is a lesser-known and lesser-used, but still very valuable tool available to add to our personal finance toolkit. While not everyone will need it, for those who do, it becomes a saving grace for their finances and peace of mind. As valuable as credit insurance is, it’s important not to jump into it blindly either. Review all the details to ensure the plan you choose is the right one for you and your family.
If you’re already struggling with debt because life threw you a curveball, don’t worry, there’s help out there. Contact one of our trained Credit Counsellors for a free, no-obligation consultation. They’ll go through all the various debt-relief options available and make a recommendation on which one is best for your particular situation.
