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A lender can protect its interest in a loan by using creditor insurance. This will compensate the lender if the borrower dies or is disabled before a loan is fully repaid. Generally, the borrower pays for these insurance policies. Such policies can be mandatory or voluntary, depending on the type of loan and the lender’s requirements.
Two common examples of creditor insurance are life insurance and disability insurance. Life insurance polices pay a lump sum, or death benefit, if the insured dies. Disability insurance pays a monthly sum if the insured is disabled and cannot work. When the person is able to return to work, the disability payments stop.
Creditor insurance is usually available as part of a group insurance policy, rather than an individual policy. Group polices are generally less expensive than the individual type. The lender is the owner and beneficiary of the group policy. The borrower is known as the insured.
For example, a bank wants to insure all its mortgage customers. The bank applies for a group creditor insurance policy. The insurance company weighs the risks of the entire group with the price of the policy. Each customer pays a fee, called a premium, to be covered under the policy. As a result, the bank customers pay a lower fee than if they each bought an individual insurance policy.
Decreasing term life insurance may be used to cover a mortgage loan. As the customer pays the mortgage each month, the outstanding balance — the amount that is insured — is lowered. The amount of the death benefit will be lowered to match the remaining loan balance. As a result, the premiums can also be lowered each month.
Creditor insurance can also be used to insure credit card balances. These policies are sometimes called credit card protection programs. The customer can choose to purchase life or disability insurance, or both. The cost of the policy varies each month, based on the credit card balance. When the customer has a zero credit card balance, there is no premium due that month.
Banks may also use creditor life insurance polices for business loans. If a bank loans money to a business owner, the bank may require a life or disability insurance policy for the owner. Such policies help ensure that the loan will be repaid. This coverage is especially important if the owner’s work creates the main source of revenue for his company.
It is important to note that the proceeds, or death benefit, of any creditor insurance policy are paid to the lender, not the insured’s family. A person would need to buy separate life or disability insurance policies to protect his family in the event of sickness or death. Life and disability polices can be purchased only from a licensed insurance agent.