You’ve likely heard the horror stories of people who lost their jobs or faced another life-altering event that caused them to fall behind on their credit card payments. This usually results in plummeting credit scores, which can lead to the inability to buy a car, home, or other large-ticket item through financing. In addition, it can substantially increase interest rates on existing credit cards and make getting new ones nearly impossible.
That’s why so many people have signed up for credit debt protection plans, which are offered by all of the major credit card issuers. Another reason people sign up is because they don’t want their families to suffer financially in the event that they die.
But a report released by the Government Accountability Office (GAO) casts doubt on just how effective these plans are. If you’re spending your hard-earned money on one of these plans, read on to determine whether or not you truly need it.
What Are Credit Card Protection Plans?
The theory behind the plans is that if something were to happen to your income stream, the protection product would cover your credit card debt. These plans cover such life events as job loss, illness that requires hospitalization, disability, divorce, death, or the adoption of a child. The issuers say that they would do one of two things in the event that you need to cash in on the plan:
- They would suspend your monthly payments and the interest until you’re able to make the payments again.
- They would completely eliminate your debt balance if you’re injured so badly that you would never be able to work again.
In the case of your payments being suspended, you would still have to pay for the protection plan since the premium is charged as a percentage of your balance and would be added to your existing credit card balance every month. However, you wouldn’t be required to pay the premium or any interest, nor would any interest accrued, until you began making payments again.
If the balance were eliminated, then there would no longer be a premium to pay because you wouldn’t be carrying a balance. Debt elimination, as well as payment suspension, would prevent your credit rating from being damaged since there would be no negative balance to report.
Most people who purchase the plans do so for peace of mind. It can be stressful to worry about losing a job and not being able to pay the bills. And for those who do get the coverage they expect, the plan can ease a difficult time by suspending their payments, or in some cases, wiping out the debt completely.
If you think there’s a high likelihood that you’ll experience a major life event such as divorce, adoption, or job loss, it may be in your best interest to at least consider a debt protection plan.
According to the GAO’s report, only about 70% of the people who enroll in the plans actually receive benefits when they apply for them. That’s far below the insurance industry’s average payout rate of 80-95%. This low rate is a direct result of the fact that the issuers have created a confusing network of exceptions, caps, and exclusions. For instance, if you want to suspend your payments because you’ve lost your job, you’ll first have to prove that you lost it unwillingly. That can be difficult if your employer decides not to cooperate. And if you’re hospitalized because of a preexisting condition, you’re out of luck.
Even more alarming is that seven out of the nine largest credit card issuers offering the plan won’t allow consumers to review the list of exclusions and caps until they have enrolled. If you are wondering whether this is even legal, you aren’t alone. Class action lawsuits have been popping up lately, accusing the credit card issuers of selling policies to people who would never qualify for the benefits.
In addition, the plans aren’t cheap. They run anywhere from $0.85 to $1.35 per month for every $100 balance that a consumer carries. So, if you carry a $2,000 balance, and pay an average of $1.00, you would tack on $20 per month, $240 a year, or $1,200 for every 5 years that you carried the coverage.
A debt protection plan may be beneficial to some people who are in a shaky employment situation, or are planning to adopt a child or get a divorce. But it’s still not an easy call because you would have to make the decision without having all of the facts. The GAO has recommended that the newly created Consumer Financial Protection Bureau look into the matter and determine whether these plans are fair for consumers. In the meantime, run your own personal numbers and decide whether or not the gamble makes sense for your finances.
Have you had success with one of these types of credit card debt protection plans? Or have you filed a claim and had it denied? Share your experiences and opinions in the comments below.
(photo credit: Shutterstock)Editorial Note: The editorial content on this page is not provided by any bank, credit card issuer, airline, or hotel chain, and has not been reviewed, approved, or otherwise endorsed by any of these entities. Opinions expressed here are the author's alone, not those of the bank, credit card issuer, airline, or hotel chain, and have not been reviewed, approved, or otherwise endorsed by any of these entities.