Lenders offer insurance or similar products that would make your loan payments if you die, become ill or unemployed, but there are costs and limitations. Here's a guide for evaluating this coverage.

Think about the last time you applied for a new loan or a credit card. Did the lender ask if you'd like to buy something called "credit insurance" or a similar credit protection product that would make your loan payments if you die, become ill or unemployed? And after you got the loan or credit card, did your lender continue to offer credit protection programs in mail solicitations or telemarketing calls? Chances are you answered "yes" to these questions. But it's also likely that you have your own questions, such as: Do I really need this insurance? And, how can I tell if this coverage is a good deal?

FDIC Consumer News wants to help you answer these questions. Why? Because we know that applying for a loan, particularly on a major purchase such as a home or a car, can be confusing for many consumers. And we realize that it's possible that many consumers may buy optional credit protection without evaluating whether they need it, how much it will cost, or if they can get a better deal elsewhere. We've also heard about instances in which some consumers have fallen prey to high-pressure sales pitches or purchased high-cost credit protection that they really didn't need or understand.

"We're all prone to focus on the benefits of an offer, written in bold, without evaluating the conditions and exclusions," says Deirdre Foley, an FDIC senior policy analyst. "You should review your financial situation and weigh the costs and benefits before deciding if this type of coverage makes sense for you."

Here's an overview of what credit protection is and what you need to know to protect yourself from high-cost or unnecessary coverage.

What Are Credit Insurance, Debt Cancellation and Debt Suspension Programs?

Credit insurance is offered with certain kinds of financing, such as some home loans, credit cards, and loans offered by department stores or auto dealers. In general, credit insurance is a type of life, accident, health, disability or unemployment insurance that will pay off a debt if the borrower dies or make monthly payments if the borrower becomes ill, injured or unemployed.

For the most part, each state government regulates credit insurance sales in that state, and the insurance department enforces the state laws and regulations governing pricing, disclosures to buyers, minimum insurance benefits, and other consumer protections.

Moreover, most types of credit insurance are voluntary. An important exception is property or hazard insurance. A creditor may require that you maintain this kind of insurance to cover the costs of repairing or replacing property (such as your home or auto) that serves as collateral for a loan. And in those instances in which insurance is required, a bank cannot condition approval of the loan on the purchase of insurance from the bank or an affiliate.

In addition, some depository institutions (such as banks and credit unions) sell "debt cancellation" and "debt suspension" programs under various names. In general, debt cancellation eliminates the debt if the borrower dies or cancels the monthly payment if the borrower becomes disabled, unemployed or suffers some other specified hardship. Debt suspension is different. It temporarily postpones all or part of the monthly payment while the borrower is facing a specified hardship — the borrower is still expected to make the suspended payments in the future. These programs are similar to credit insurance products in terms of their function, but fees and other features may be significantly different. Debt protection programs are offered by depository institutions directly, not by insurance companies. These programs are subject to regulation by the appropriate federal or state depository institutions supervisor.

The Pros and Cons

Credit protection products may provide borrowers peace of mind and security, and can be a good deal for certain consumers. Providers of credit protection also advertise the product as "easy to buy" because, unlike traditional life or disability insurance, it often does not require a physical examination, premiums are the same regardless of your age or health, and coverage can be purchased in small dollar amounts. Credit protection programs may be the best or only coverage for some older consumers, people who smoke or are ill, or workers concerned about making loan payments if they lose their job.

Also, other types of life and disability insurance may carry higher minimum-coverage amounts than those for credit insurance, which is based on the size of the consumer's debt. This means, for example, that instead of buying a traditional life insurance policy for $50,000, a consumer would obtain credit insurance based on the loan balance, which may be much less.

However, despite these benefits, credit insurance and debt cancellation or debt suspension programs typically cost far more than a comparable term life insurance policy (which provides protection for a specified period) and perhaps other insurance not sold with a loan. These credit protection programs also can only be used for one purpose — to repay a specific debt.

Let's say you buy credit insurance or debt cancellation/suspension coverage to pay off a

Most types of credit insurance are voluntary. And in those instances in which insurance is required, a bank cannot condition approval of the loan on the purchase of insurance from the bank or an affiliate.

credit card debt if you become sick or die, and you consistently carry a card balance of $4,000. Various sources indicate that you'd likely pay between $150 and $350 a year for credit protection. For that money, you might be able to buy a much larger term life insurance policy or add to your emergency savings, both of which could be used to pay off any obligations, not just the credit card debt.

Other restrictions, limitations or costs may apply to the various credit protection programs. Examples:

• Some debt cancellation programs limit death benefits only to accidental death — a relatively infrequent occurrence compared to death because of illness, disease or natural causes. In contrast, credit insurance providing a death benefit is rarely limited to accidental death.

• The typical credit insurance policy covering disability or unemployment will make the borrower's monthly payment on a loan during the benefit period. In contrast, a debt suspension program only puts loan payments on hold.

• If you become ill or unemployed and you apply for benefits under a debt suspension program for a credit card or a home equity loan, the contract probably will indicate that you cannot continue using the card or equity loan. "If you're unaware of this restriction, you may be cutting off an important source of emergency cash just when you need it the most," according to April Breslaw, Chief of the FDIC's Compliance Examination Support Section.

• Some creditors offer single-premium credit insurance, which means that the premium is paid in a lump sum up front instead of monthly or annually. The one-time payment typically is so large that consumers add the fee to their loan amount and then must pay interest on it each month. This adds significantly to the monthly loan payment and the overall cost of the loan. Moreover, even though the premium may be added to the loan balance and paid for 15 to 30 years, it's possible that the insurance may only cover the first five to 10 years of the loan.

4. Pay attention to loan documents and monthly statements from your lender and question any unusual charges or fees. For example, if you fail to maintain the required property or hazard insurance coverage or you forget to give the lender evidence of your coverage, the creditor typically reserves the right to purchase the insurance and charge you for it, perhaps as part of your loan payment. If you're not monitoring your payments, you could be paying for a property insurance policy purchased by the lender that is more expensive and more limited than what you could obtain by shopping around.

5. Try to resolve problems as soon as possible. First contact the creditor or insurance company. If you're not satisfied with the outcome, contact your state insurance commissioner or, in the case of a debt cancellation/suspension contract, the appropriate federal or state regulator. Also, retain copies of your loan documents and related credit protection policies, terms and conditions. You may need to refer to this information if you have a question, a concern or an insurance claim.