Credit protection insurance is a good example of a consumer rip-off
that affects millions of people, yet receives little attention in the
financial media. Simply stated, you should NEVER buy "credit protection
insurance," or a "payment protection plan" or any other similar type of
credit-related insurance. Let's take a look at how these programs work
and why they are a bad deal for the average consumer.
First, let's dispense with the scam version of this insurance. With
identity theft in the news so much lately, con artists have set up
telemarketing boiler rooms to call people and try to scare them into
buying worthless credit insurance products. Representatives will try to
convince you that you're at risk if someone gets hold of your card and
starts making fraudulent purchases in your name. When they call, they
may even pretend to be from the "security department" of your bank. In
fact, they may actually be part of an identify theft ring, with the
goal of getting you to disclose personal information over the phone. Or
they may simply be trying to make a fast buck by selling you an
insurance policy that you absolutely don't need.
Under Federal law, you are limited to a maximum of $50 liability for
unauthorized use of your credit card. If you didn't authorize a charge,
don't pay it! Follow your credit card bank's procedure for disputing
bogus charges. You simply don't need insurance to protect yourself from
a situation that is already covered by Federal law!
Now, what about those "payment protection plans" offered directly by
the big credit card banks? These are plans that promise to cover your
minimum monthly payments for an extended period of time (usually 12-24
months) if you get laid off from your job, become hospitalized due to
an accident or illness, or become disabled. On the surface, a plan like
this sounds like a pretty good idea. After all, how could you keep up
with your payments if you suddenly lost your job or became too ill to
work?
Of course, you should not be carrying balances on your credit cards
anyway. If everyone paid their balances in full every month, then
credit protection insurance would not even exist in its current form.
You are charged for the insurance based on the amount of debt you're
carrying on the card, so if the balance is zero, then there is no fee.
In fact, some bank representatives use this as part of the sales pitch
when trying to entice people to sign up for that "free 3-month trial"
on their payment protection plan! They attempt to talk you into adding
the insurance now, while you don't need it and when there is no cost,
in the hope that one day you will start carrying a balance. By then,
you'll probably have forgotten you signed up, and you'll wonder what
those mysterious charges are on your statement every month.
If you do carry balances on your cards, credit protection insurance is
still a very bad deal. To see why, let's look at the math here. A
typical loss protection plan costs 85 cents for every $100 of balance
carried on the card. So if you're carrying a debt of $5,000 on the
credit card, it will cost you $42.50 per month to buy the insurance.
Over the course of 12 months, you will spend $510 under this scenario.
That's equivalent to paying an extra 10% in annual interest!
A light bulb should be shining over your head right about now. Why not
take that same $42.50 per month and use it to pay down the balance
faster? Good question. When you consider that most consumers who have
credit protection carry it year after year, without ever becoming
eligible for a claim against the insurance policy, the amount of wasted
money can add up to a truly staggering sum.
Continuing with our $5,000 example, with a typical minimum payment of
$125/month, it will take more than 26 years to pay off the balance in
full, at a cost of $7,115.42 in interest. By applying that extra $42.50
per month that would otherwise go toward the insurance, for a total
monthly payment of $167.50, you'll have the debt paid off in only 40
months! And you'll have saved $5,435.22 in interest charges. It simply
makes no sense to waste this money , especially when you consider that
the credit protection plan is normally only good for 12-24 months
anyway.
There's another important factor involved here. Credit protection is
also a bad deal because the eligibility requirements are so very
restrictive. When you read the fine print, you'll realize that there
are all kinds of situations that aren't covered. Let's say, for
example, that you've been fighting a medical condition for some time.
So you buy the insurance thinking it's a good idea. Eventually, you end
up in the hospital for treatment and recovery. Can you breathe a little
easier knowing your credit card payments are covered? Nope. Most of
these policies have exclusions for pre-existing conditions. And there
are numerous other loopholes that allow the bank to deny your claim
under the policy. In view of the lousy math and the restrictive nature
of this type of insurance, these programs should really be named "bank
profit protection" instead of "credit protection insurance." Instead of
spending good money on an insurance plan that you will probably never
use, you're far better off applying that same amount toward paying off
the debt early.
