Debt protection is becoming more available today as part of various credit products. The idea is simple: If something happens and you can’t make payments, your payments are suspended, forgiven, or deferred until you can resume your monthly schedule. It’s essentially a type of insurance.
The events of the past few months show that we live in uncertain times, so this protection can be valuable. But the keyword here is “can.” Sometimes it’s valuable, and sometimes it isn’t.
Whether it is or isn’t is a matter of your personal situation. But we can offer questions to ask yourself as you consider any protection offer. Certainly, the rising unemployment rate means more individuals might want to evaluate these types of programs.
1. Is it a service or a benefit?
Some offers of this kind are a free service that comes with your loan or credit card. It might be rolled into a higher interest rate, but it’s an integral part of the deal: No payment protection program, no loan.
In other cases, it’s an extra benefit that costs additional money. You can take it or leave it, much like the service package the home improvement store offered you on your fridge. It may be an optional package offered at the time you get the loan, something you can buy during the loan’s life or a third-party protection offer.
Look at interest rates for a protected loan and compare it to the rates for a loan from a competitor without the protection. Get exact details of the cost of a program that’s an extra service, extrapolated, and totaled over the life of the loan. At the core, neither option is necessarily better or worse, but you’ll want to know exactly how much any given offer costs before making a final decision.
2. What are the qualifications?
All payment protection plans promise to help if you become unable to make payments on the loan, but not all policies are the same. For example, one plan might begin covering payments after a doctor says you can’t work, while another might wait until you officially qualify for Social Security or worker’s compensation status.
Some policies list a comprehensive (and often exclusive) list of reasons for the policy to be utilized. One policy might include unemployment, while another explicitly does not include unemployment. Some policies seem to go out of their way to obfuscate their classifications, which can be a bad sign.
Always read and fully understand the qualifications for the debt protection insurance you’re considering, and raise a suspicious eyebrow if they’re too complex.
This is especially important if you suffer from a medical condition or other factors that make it more likely you might stop being able to earn income. If the likely cause for your work stoppage doesn’t qualify under a plan, that plan isn’t a good match for your needs.
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3. What kind of protection is offered?
Find out what happens when your payment protection is activated. How long does it take to go into effect? How many missed or late payments will go on your credit record even with this policy in place? Will it cover a portion of or all payments? Does it pay for just interest or pay down the principle as well?
Also, find out if your plan offers forgiveness, forbearance, or deferment. Each has important differences for the long-term handling of your loan:
- Forgiveness means the plan pays off some or all of the interest and principal of your loan, as though you had sent the money in yourself.
- Forbearance means the company doesn’t report you to the credit bureaus or inflict penalty charges on your missed payments. No payment is recorded, and your loan accumulates compound interest throughout the forbearance period.
- Deferment puts the loan on hold. You make no payments and the company charges no interest. When you can pay again, you resume payments as though no time had passed.
Another type of protection, usually offered by third parties, is more like traditional insurance. If you qualify for the policy to pay out, you receive a lump sum of cash you can use to pay off the balance of the protected loan.
4. What are the limits of protection?
Some plans offer payment protection for as long as you’re unable to pay or until the payments under the insurance reduce your balance to zero. Others attach a maximum for how much the policy pays out. These limits are either time-based or total-based.
A time-based limitation makes or protects payments for a specified number of months, at the end of which time the protection goes away and you are responsible for the loan. A total-based limitation makes or protects payments until those payments add up to a specified sum, at which time the coverage ends.
It’s important to know what limitations exist on any payment protection insurance you’re considering and what happens after the limitation is reached. Are you immediately on the hook for all the payments you’ve missed? Do you just pick up where you left off? Does the policy continue to help you but in a limited way?
5. Do you have less-expensive options?
The purpose of debt protection insurance is to make sure your assets and credit record are safe if you find yourself unable to earn the money necessary to keep up on payments. It’s possible you have other, less-expensive options that can accomplish the same goals. Some common examples include:
- A home equity line of credit sufficient to cover payments for several months
- A whole life insurance policy with an accumulating cash value that keeps up with the debt you want to protect
- Emergency savings at a level that can keep payments up for a while
- Short-term and long-term disability insurance
You can also consider structuring your debt in ways that protect your family. For example, you can keep unsecured debt in the name of one spouse only, so that if that spouse passes, the other is not responsible for payments.
6. What commitment is required?
Does the payment protection plan require you to carry it for the life of the loan? If so, it may not make financial sense as the balance on the loan approaches zero. Or can you cancel the policy at will? Make sure there are no penalties for early cancellation and determine how long it takes to cancel.
Beyond these questions, it’s always a good idea to look into the company offering the payment protection plan. Not all of them are predatory, but some are. Talk to previous and existing customers, look them up on the Internet, and investigate them thoroughly to make sure that, if you decide to purchase this plan, the company that sold it will keep their end of the deal.
Article by Christopher Crawford. Crawford is based in Montana, where he provides consulting services to banks and financial institutions.
