How Credit Insurance Hurts Homeowners and Leads to Foreclosure

Some homeowners, when they originally purchase their home or refinance, are pushed into an expensive "credit insurance" policy. Despite how they are sold to the borrowers, though, these schemes can often just be one more way that lenders enrich themselves by taking advantage of the financial ignorance of most borrowers. Abusive credit insurance can also be used as a defense against a foreclosure lawsuit.

But what is credit insurance? There are two common types of it -- a credit life policy and a credit disability or accident and health policy. Both can be abused by lenders when they force expensive policies on borrowers who may receive little or no benefit from them. Although some policies may be advisable in some cases, expensive policies that have limited or no benefit for the borrowers are a sign of abuse.

Credit life policies will pay off the existing mortgage in the event the covered person dies. Credit disability coverage is designed to be used by borrowers to pay their monthly mortgage expenses in the event of a disability or other interruption in income due to health reasons. Both can be quite helpful for homeowners in certain situations, but these types of insurance are also offered cheaper through other sources.

One reason that other insurance providers may offer such policies cheaper is that the lender, when it pushes homeowners into a credit insurance policy, is often compensated directly by the insurer. The insurance company pays the mortgage origination company for placing the insurance, which gives lenders incentives to recommend the highest-cost policy available.

The potential abuse of such policies comes from the way that the creditors (the mortgage lenders) benefits from the sale of the insurance. Lenders receive a commission, in most cases, determined by a percentage of the total premium the borrowers have to pay. The higher and more expensive the coverage, the more then bank gets paid by the insurer. Of course, this means that the highest cost coverage is offered.

Also, borrowers who purchase a credit insurance policy voluntarily may have the premiums added to the balance of their loan amount. This means that the bank will be able to charge interest on the insurance policy premiums, thereby increasing the cost even more over the life of the loan. This raises the effective interest rate of the loan and increases the profit of the loan to the bank.

While most homeowners may just not be aware of how these policies work and the lenders' incentive in offering them, the practices described above may not be outright abuses. However, some borrowers have been pressured into paying for insurance policies where they are ineligible to receive any benefits under the terms of the policy. This is an obvious abuse and mortgage companies can be held responsible for it.

However, the most important point for homeowners to remember is that they have a choice with these policies. If the lender is forcing them into one, they can always go with a different bank or lower coverage amount. A future article will look at how the insurers inappropriately deny benefits even for borrowers who have adequate coverage, as well as legal claims against the lenders and insurers.