I have received a lot of questions about credit insurance and whether or not the fees are worth it. Below is the reprint of an excellent post on the real costs of credit protection from a few months ago.
-Raj Patel
A week ago I spoke to a woman with significant credit card debt. By taking advantage of balance transfers she had gotten her interest rates down to less than 10% and she was feeling good. Then came the question: “What should I do about credit protection?”
As a group of bloggers concerned with helping people get out of debt, we talk a lot about interest rates and how to manage or pay off debt. As a general rule, we focus on paying off highest-interest loans, calling to negotiate lower rates, or taking advantage of balance transfer offers to lower rates.
However, we often ignore one high-cost “feature” that lenders convince many borrowers to sign up for without fully understanding the cost: credit protection or credit insurance. These policies often run for $.85-$1.35 per $100 of covered balance and give enrolled borrowers various “rights” should they experience an income disruption such as loss of job. Although these benefits seem valuable, they’re often oversold. For instance, most credit protection policies generally postpone the need to make a payment if the borrower loses a job. However, often interest continues to accrue. So despite the coverage, you’re really only buying the right to not make a payment while interest continues to accrue.
So how much do you pay for this coverage? At $.85-$1.35 per $100 of covered balance, this effectively adds 10-16% per year to your bill. For most lenders, the actual benefit ratio (the cost of the benefits compared to total fees) is between 10-20%. So for each dollar you pay out in fees, you can expect to get only $.10-.20 in benefits. Not a great investment.
Cancelling this coverage will cut your costs right out of the gate and allow you to make more progress in paying down your debts. Unless you know with a high degree of certainty that you’re about to lose your job, you’ll almost certainly be better off by cancelling this coverage and using the proceeds to pay off debt as quickly as possible.
Scott Crawford is CEO of DebtGoal.com, a do-it-yourself system for lowering your interest costs and getting out of debt. DebtGoal.com incorporates all of the techniques discussed in this post and can help users understand and get visibility to and manage their debt finances.
