I got another round of great letters this week, so I am devoting this column to Q and A. I love hearing from readers and if your question is one others may have top-of-mind, chances are I will answer you here in this column. Bring it on!
Q: I am a 62-year-old single woman, self employed (I clean homes). My business has suffered the past year, so I have been cutting back on all that I can --cable, cell phone, etc. I had to drop my life insurance that was costing me $129.00/per month. I have a daughter that has 2 children and she has had a rough time raising them on her own. I have been able to help in the past, but not now. I would like to see them receive something from my passing. I was wondering what you feel about credit life on my $38,500 mortgage. It would have to be around $40 a month, included in mortgage payment, for me to be able to swing it. What do you recommend?
There are three reasons (actually, there are probably more than three) why I do not recommend you buy the credit life policy. For those who haven't heard of it, credit life insurance is insurance that pays your debts if you die. The first is simple: when you die, your debts die with you. That is especially true of unsecured debts like credit cards. Your family members are not responsible for finishing up the payments on unsecured debts, as long as their names are not on the bills.
It's also true of mortgages, but with a caveat. Your heirs are not responsible for making payments on your mortgage. If the mortgage is not paid off, the bank will simply take possession of the home. However, if you have a lot of equity in your home, you won't want the bank to grab it, because then your family members lose out on the chance to benefit from that equity.
So, quite simply, it is a product you don't need, though your creditors would rather you not know that.
Reason number two is that your family members do not "receive something from your passing" if you have credit life insurance. Your creditors do. The policy pays your debts off. I believe you are saying you would like to be able to pass along some cash to your grandchildren when you die. This product will not accomplish that. If I am wrong and you are saying you would like your mortgage to be paid off, so that your daughter and granddaughter may live in the home, I still don't like it. You are a relatively young woman! Given that you have been doing a physical form of work until recently, I suspect that you are in pretty good health. You could have this mortgage paid off long before your death, in which case you will have just wasted $40 a month!
Alternatively, if you have $40 per month to spare and want to hand your home down to your daughter and her children, then put the $40 toward prepaying your mortgage. Here's how it works. When you send extra principal each month to the mortgage company, (you must make sure your bank knows you intend your overpayment to go toward principal) that means there is less principal for the mortgage company to charge you interest on. You finish paying off your mortgage years early and save thousands in interest! Let me spin this out for a moment with a little guess work. Let's say you have 10 years left on your mortgage and your interest rate is 7 percent. By sending in just $40 extra per month, you will save $1,870 over the life of the loan and have the mortgage finished off 13 months early.
If everything else remained the same, but you were able to bump up your monthly extra payments to $60, then you would save $2,638 in interest and finish paying off your mortgage 19 months early. That is the awesome power of reverse compounding. Here is a terrific calculator for anybody who wants to investigate how much time and money prepaying would save them.
The third reason I am against the credit life idea is that the premiums for credit life insurance are usually much higher in relation to what these policies pay out than regular life insurance policies. Some consumer advocates have even labeled credit life a "scam." I won't go so far, because I define scams as fake offers meant only to steal your money. Credit life is more of a rip-off. It's a real product, but usually terribly overpriced and misunderstood. You would be better off shopping around for a new standard life insurance policy, to see what you can get for $40 a month. I hope this answer gives you –and everybody reading—more clarity. Good luck!