What Is Credit Insurance?

When you take out a loan or use a credit card, you may intend to repay what you borrowed, but what if you can’t?

Some lenders offer credit insurance as an extra layer of assurance, but it’s a costly add-on that may not provide much value to borrowers.

Here’s what to know about credit insurance.

What is credit insurance?

Credit insurance is an optional insurance policy offered by lenders and creditors to cover your loan or credit card payments if you cannot pay due to unemployment, illness, disability or death. It prevents you from defaulting on your loan if you’re no longer able to make the monthly payments.

Debt cancellation and suspension plans work similarly; all these products ensure the lender is repaid if you’re unable to make payments.

Credit insurance may seem to function like life or disability insurance, but there is a crucial difference: credit insurance pays the lender directly, instead of you or your family.

Lenders may give you the option to buy credit insurance — also called payment protection insurance — when you apply for an auto loan, unsecured personal loan or credit card.

Most borrowers don’t need credit insurance if they have existing insurance policies in place.

Types of credit insurance

There are four main types of credit insurance coverage:

• Credit life insurance: Makes the remaining loan payments to the lender in the event of your death.

• Credit involuntary unemployment insurance: Makes a limited number of monthly payments to the lender if you lose your job through no fault of your own.

• Credit disability insurance (also known as credit accident and health insurance): Makes a limited number of monthly payments to the lender if you become disabled or ill.

• Credit property insurance: Covers destruction to personal property used as collateral to secure a loan.

A lender may bundle different types of credit insurance into a single offering.

The cost of credit insurance

The cost of credit insurance is based on the type of loan, type of insurance, loan amount and the state where you live. The price is also influenced by the commission that insurers pay lenders.

Credit insurance premiums are typically more expensive than other insurance premiums. A 2018 report from The Pew Charitable Trusts found that credit insurance increases borrowing costs by more than a third.

If you get credit insurance, you can expect a higher monthly loan payment than if you opted out. The credit insurance premium is often added to the loan amount, leaving you to pay interest on the loan amount and the added insurance premium. For revolving loans like credit cards, the premium is added to the monthly statement and varies according to your balance.

Do I need credit insurance?

Credit insurance is not required to get a loan or credit card. NerdWallet does not recommend taking credit insurance if you already have a traditional disability or life insurance policy that will cover your obligations if something goes wrong.

Instead, use the money you would have paid for credit insurance to build an emergency fund. Building up your savings can help you make payments during an income gap or unexpected shortfall.

If you’re struggling to make loan payments, ask your lender about hardship assistance. Some lenders allow you to defer payments or may temporarily modify your loan agreement.

» MORE: What happens to your debts after you die?

What to consider before getting credit insurance

If you are considering getting credit insurance, here are a few things to know:

It’s optional. If you’re denied a loan for not signing up for credit insurance, you can file complaints with the Consumer Financial Protection Bureau, Federal Trade Commission, or your state attorney general.

It may not be included in the APR. Lenders often disclose the cost of credit insurance separately from the annual percentage rate. (Military members will see the cost included in the loan APR.)

It could make your loan unaffordable. A credit insurance policy adds to the cost of a loan. Unscrupulous lenders may market credit insurance to consumers who have low credit scores in attempts to increase the loan cost.

The Federal Trade Commission suggests you ask these eight questions before choosing to buy credit insurance: