What is credit insurance and do you need it?

If you're worried about an event like a job loss or a sudden disability derailing your auto loan, personal loan or even mortgage repayment, getting credit insurance might sound like an ideal solution to protect yourself.

Credit insurance is a type of insurance coverage that's often sold by lenders alongside a loan. It can be activated and make payments to your lender if you've experienced one of those scenarios or if you die unexpectedly.

While it could help you avoid falling behind on a loan, it can be expensive. The premiums can be rolled into the cost of the loan, meaning you'll pay interest on the coverage. And, it can only pay for your loan — not the other expenses that could also crop up after a major life change.

Here's what you need to know about credit insurance, and alternative insurance you might consider instead.

Credit insurance is a type of insurance policy typically sold by a lender when you take out a loan. The lender can help you make payments in the event of something unexpected, depending on the type of coverage you choose.

There are several kinds of credit insurance according to the National Association of Insurance Commissioners (NAIC), including:

• Credit life insurance: Pays off all or some of your loan if you die.
• Credit disability insurance: Makes monthly payments on your behalf for a set duration if you face an illness or injury.
• Credit involuntary unemployment insurance: Makes some monthly payments for you if you're laid off.
• Credit property insurance: Covers personal property used to secure a loan as collateral if it's destroyed.

These policies typically cost between 1% and 5% of the monthly loan payment, according to online bank and lender SoFi. For a $500 monthly loan payment, credit insurance coverage would cost between $5 and $25 per month. However, the exact price can also depend on your age, location, and the length of your loan.

There are a few reasons why getting credit insurance isn't always the right way to protect yourself and your finances.

First, this type of coverage is often rolled into your loan total. While that prevents you from paying up front, it means you'd pay interest on the amount you finance and the amount the coverage costs. That can make your coverage — and your loan as a whole — more expensive in the long run.

Second, these policies pay your creditor directly, not you. As a result, the funds can only be used for the loan. Additionally, they're designed to take care of your loan, not other expenses you or your family might incur without your income.

Lastly, these policies can be relatively expensive, according to NAIC. Compared to the cost of a term life insurance policy — an affordable kind of life insurance that lasts from 10 to 30 years and can help your family cover any expenses they might need to if you died unexpectedly — you could get coverage that lasts longer, is more flexible, and has higher payouts for about the same monthly price.

Credit insurance can only pay your lender for your loan. On the contrary, life insurance or disability insurance could help you or your family pay for other needs if something unexpected happens, including expenses like loans.

Here's what you need to know about these two types of insurance coverage.

Find affordable life insurance

Life insurance can help your family cover debts and expenses

If you have a family depending on your income, chances are that you need life insurance. Because it can cover any debts you might leave behind or expenses your family would need to pay in your absence, it could be a better fit than credit insurance.

Term life insurance policies are the most cost-effective and simple policies on the market. With this type of coverage, you pay a set monthly premium for a period of time, typically 10 to 30 years. If you die in that time frame, your family will receive a death benefit, which is chosen when you bought the policy. This can range from $100,000 to $1 million or more — a ballpark way to find out how much life insurance you need is to multiply your salary by 10.

While these policies lapse once the term is over, they can be an affordable way to make sure your family is set if the worst happens.

Getting life insurance can be relatively simple, as some of our favorite companies have moved the process for getting a term policy entirely online. Ladder offers life insurance policies for up to $8 million (or up to $3 million with no medical exam). This insurer also allows you to change your coverage amount later if your life and needs change.

Ethos offers life insurance policies that don't require a medical exam for up to $3 million in coverage. Plus, many applicants can get quotes easily in minutes.

Disability insurance can help you and your family cover bills and expenses if you're not able to earn the income you hoped to because of an illness or injury. Unlike credit insurance, the funds are paid to you and can be used as you need, from making loan payments to saving for retirement.

There are two types of disability insurance. Short-term disability can cover your wages during a health issue you're expected to recover from. Long-term disability can step in if you're facing lifelong, chronic conditions and replace your wages until you reach retirement age. While many people get short-term disability insurance from their employers, long-term disability is frequently bought on your own or as a supplement to the coverage you get from work.

Guardian is one of our top choices for disability insurance, as it doesn't require medical exams for policies of up to $3 million.

Comparison shopping is the best way to ensure you're getting the best price on disability coverage. Online broker Breeze allows you to compare quotes from several insurers and get approved entirely online.

At CNBC Select, our mission is to provide our readers with high-quality service journalism and comprehensive consumer advice so they can make informed decisions with their money. Every insurance story is based on rigorous reporting by our team of expert writers and editors with extensive knowledge of insurance products. While CNBC Select earns a commission from affiliate partners on many offers and links, we create all our content without input from our commercial team or any outside third parties, and we pride ourselves on our journalistic standards and ethics.

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