Credit insurance guarantees payment of a debt if the borrower is unable to pay. It is sold by credit card companies, car dealers, finance companies, department stores, and other lenders who make loans for personal property. Mortgage insurance is the same thing, but for real estate loans.
There are four main types of credit insurance:
Credit insurance, for the most part, is a rip-off. Consumers spend billions each year on credit insurance, often without knowing what they have bought. Or they may believe it is required, when it’s not. Sometimes all it takes to purchase it is to check a box on the credit agreement. And the seller or creditor may have already checked the box, without your knowing it, before you sign the credit agreement. The insurance may have limitations and exclusions so that in many instances when you might want insurance, you may not be covered anyway.
Many lenders will tell you that credit insurance is required to get a loan. This is almost always wrong. For the most part, you cannot be required to buy credit insurance. The main exception is for credit property insurance: Creditors can require you to buy this type of credit insurance in certain circumstances. But even if property insurance is required, in most states, creditors cannot force you to buy the insurance from them. The creditor must allow you to shop around and buy from another company.
Federal and state laws regulate credit insurance. One important federal law applies to private mortgage insurance (PMI). Lenders sometimes require PMI if a purchase or refinancing loan is for more than 80% of the value of your home. It ensures the lender will be paid if you default on the mortgage. After you have paid a certain amount of your loan, the law allows you to cancel the insurance.
In a few states, lenders cannot require credit insurance except for loans to buy real estate.
To learn about other provisions to avoid in consumer loan contracts, see What to Watch Out for in Loan and Credit Contracts.
This is an excerpt from Nolo's Solve Your Money Troubles: Debt, Credit & Bankruptcy, by Margaret Reiter and Robin Leonard.