Worried about debt after death or unemployment? A debt protection plan could cover you, but may be overpriced. Here are some better ideas.
These days, you can buy insurance in almost every area of life. In addition to your life, home, car, and health, you can buy policies to protect pets, weddings, cell phones – even your debts.
Debt protection comes in various forms. Some plans pay off your balance if you die, others cover minimum payments if you lose your job or become disabled. The policies are pushed by providers of all kinds of debts, from credit cards to mortgages.
While protecting yourself from a loss of income seems sensible, when it comes to debt protection, the devil is in the details. In the video below, Money Talks News founder Stacy Johnson takes a closer look at these plans. Check it out, then read on for more…
How debt protection works
There are different kinds of debt protection. Some will extinguish part or all of a debt if you die during the coverage term. Others guard against unemployment, promising to cover a certain number of minimum monthly payments if you’re laid off. There are plans that will make your payments if you become disabled. There are even plans that pay three minimum monthly payments if you get married or divorced, adopt a child, or buy a home.
But as I said above, the devil is in the details. For instance, benefit caps usually apply – the max the protection will pay could be as little as $500. For unemployment protection, qualifications may include being a permanent employee working more than 30 hours a week for at least three months, then qualifying for state benefits after two months without work. And for either disability or unemployment, you may have to provide regular proof you can’t (find) work.
Don’t even think about debt protection without understanding the fine print. Ask about limitations, waiting periods, how to cancel, and whether you can get any refund for doing so.
Cost vs. benefit
As with anything you buy, it’s important to consider what you pay for what you get.
As Stacy mentioned in the video, a Government Accountability Office study from 2011 revealed creditors took in about $2.4 billion for debt protection that year on 24 million accounts – but paid only about 21 percent of that back in benefits. That’s super-profitable for them, which makes it questionable for you.
Prices typically fall in the range of 85 cents to $1.35 per $100 owed, so on a $5,000 credit card balance, you’ll pay up to $67.50 a month, or $810 a year. In addition, since the cost is added to the balance, you pay interest on it too.
Pushing too hard
In July, the Consumer Financial Protection Bureau fined Capital One $210 million for allegations that it deceptively sold services like identity theft and debt protection. Two-thirds of that was refunded to two million customers.
Also in July, HSBC set aside $1.3 billion for British customers pushed into buying protection. And in June, Hawaii sued banks including HSBC, Bank of America, and JPMorgan Chase for improperly pushing debt protection and other “add-on” credit products.
As a result of these actions, some big banks are getting out of the protection business. A couple of weeks ago, Reuters reported Bank of America and Capital One have stopped offering payment protection. (BOA will continue providing it for free to existing customers for the next six months, and a settlement may mean $50-$100 refunds for affected customers.)
Chase still offers it to existing customers but says it stopped peddling protection to new ones last October. Citigroup “paused telephone sales” of the products but still offers them online and by mail.
Alternatives to debt protection
Debt protection makes the most sense when you expect to be unable to pay your bills soon and have no other options. Otherwise, a few alternatives may have more appeal…
1. Build an emergency fund
If you’ve got a $5,000 credit card balance, rather than paying $67 a month for protection, put that money in a savings account instead and create a cushion to soften the blow of cash flow problems. You’ll have money to cover several minimum payments if your budget gets squeezed, and rather than racking up charges to cover a specific debt, you’ll have money on hand to use however you choose.
2. Pay down debt
Instead of prolonging the problem by spending money on debt defense, work on your offense. Check out A Simple System to Destroy Debt. Bringing down that high balance will mean getting out of debt faster and spending less overall – and may improve your credit score by lowering your credit utilization ratio.
3. Consider a life insurance or disability policy
Another option is checking out broader coverage that may offer more protection at a better price. Disability or life insurance, for example, will provide cash that can be used for expenses other than debt. But be sure to study the details and comparison shop. Start at the Money Talks News insurance page, which includes a life insurance search tool.