Loan Protection Insurance: What You Should Know

If you're taking on some credit, someone might have offered you loan protection insurance or suggested that you get some. Maybe you're about to buy a home or a new car, you've taken out a large personal loan, or you have significant debt on your credit cards. Or if you're a small business or director, you might be the guarantor of a large loan that your company has taken out.

Is this loan protection a good idea? Is this kind of insurance worth it? Just what does it cover? This article will help you sort through it by explaining loan protection insurance and weight its pros and cons.

Mortgage Protection Insurance

Mortgage protection insurance (MPI) is specifically for homes. It is essentially a form of life insurance: if you die, the insurance company will pay off your mortgage in full (get advice on Choosing the Right Kind of Mortgage).

Some policies also pay if you become disabled. But in this case, the mortgage will not be paid off in full; instead, the insurer will make your monthly payments up to a maximum time, as specified by the policy (typically one or two years).

Note, however, that an MPI is not the same thing as the similar acronym PMI. A PMI is private mortgage insurance, and it's a policy that is required if you put a down payment of less than 20% on your mortgage. Its sole purpose is to pay off the bank loan if you default and the bank forecloses. It does not pay you or your beneficiaries if you die or become disabled.

Is an MPI Worth It?

Buying an MPI might make sense for some people. If you have serious health issues, for example, and are unable to get life insurance at a reasonable rate, an MPI might be a good recourse. In most cases, acceptance is guaranteed, meaning you won't be required to submit to (and hence cannot be turned down because of) a health examination).

It's also worth considering if your occupation puts you at high risk of injury. If you are, it will be cheaper than buying disability insurance and it will cover one of your most significant expenses (your mortgage) if you suffer an accident or get a little too cavalier with the heavy machinery at work (find out Why You Need Disability Insurance).

In those situations, an MPI is a good choice, but for most people a standard life insurance policy makes more sense. For one thing, the premium for your MPI will be set for the life of the policy, but the amount it will pay if you die will decrease as you pay off your mortgage. A whole or term life insurance policy also has fixed premiums, but because the payout isn't tied to the value of a particular loan, the policy will pay the full amount no matter how long you hold it before someone files a claim (learn more in Before You Commit: Life Insurance 101).

Another advantage to opting for life insurance is that your beneficiaries will have more flexibility with how they handle the insurance payment. An MPI pays off the mortgage, but a life insurance benefit can be used to, say, make investments instead of a mortgage payment (for great advice on how to grow your money, check out these Top 25 Personal Finance Bloggers to Follow on Twitter).

Other Types of Personal Loan Protection Insurance

There are other types of loan protection insurance that function essentially the same as an MPI but insure loans other than mortgages. You may, for instance, get policies that will pay off personal loans, credit card debt, and auto loans in the event of your death or disability.

Generally, the same pros and cons apply to these, and whole life or term insurance is often the better option.

If you want to investigate your loan protection options, come to it with a full understanding of exactly what is covered and what the premiums will be. This will help you accurately compare them to the life insurance policies available to you.

Loan Protection for Small Businesses

Owners or directors at small businesses are sometimes required to guarantee payment on the loan with their personal assets. If the policy isn't required and the business has enough assets to guarantee the loan, it might still be a good idea to consider this kind of protection. Ask yourself whether the company would be able to flourish and keep paying its debts if one of its key members were to die or become disabled (find out whether you should buy key person insurance for any of your employees).

A loan protection policy can provide cash to repay the loan on the death or disability of someone who has personally guaranteed the loan or on the death or disability of someone who is key to the success of the business. That way, the policy not only protects the individual whose assets are at stake, but also the business whose success depends on its key members.

When a small business takes out a sizeable loan, loan protection insurance is usually an excellent idea. Shop around for a policy that gives you the protection you need at a price your company can afford.

Consider Carefully

Taking on a heavy loan means taking on a lot of risk. And like all major risks, it's worth insuring against it. In many cases, life insurance provides coverage that will be sufficient to handle any debts we've left behind. Loan protection, however, is an option for people who cannot find affordable or suitable life insurance or disability coverage.