San Diego, CA - The new product
being pushed on borrowers by lenders is known as debt
protection, not to be confused with debt cancellation, the
latter being closer to credit insurance of days gone by.
The debt protection gives the subscriber certain
leniencies in loan repayments, should a defined and
protected event occur.
Articles have begun to appear in some banking, credit
union, and credit card publications touting the benefits
and profits associated with peddling of debt protection
products to borrowers. When that happens, it's time for a
closer look.
What is debt protection? A debt protection product is a
two-party agreement between a lender and a borrower. They
are considered optional loan products and are not
regulated as insurance products.
The borrower pays the lender a fee and in return, the
lender agrees to cancel, suspend or otherwise modify the
terms of the loan agreement if certain, named events
occur. This is usually handled as an addendum to the loan
agreement and describes how the debt may be cancelled,
suspended or otherwise modified. The agreement also
describes the so-called triggering event, such as death,
disability, involuntary unemployment, family leave or any
number of other events. The lenders are liable for any
costs associated with these products.
They are marketed under a variety of names such as Credit
Guard, Debt Protect, Premier Credit Protection and First
Protect among numerous others. The actual fee paid by the
borrower is set by the lenders, however the average cost
on several credit card agreements reviewed by the ICFE is
$.85 per $100 of loan balance or $8.50 per thousand
dollars of balance carried.
Here is how the industry describes their various product
options.
Debt Protection Product -products offered in conjunction
with lending to provide for the formal restructuring of
debt when a protected event occurs.
Debt Cancellation Contract - Some or all of the debt is
cancelled or forgiven. Examples include canceling the
principal balance in the event of death, canceling the
remaining loan balance if a vehicle is totaled, or waiving
a monthly payment in the event of disability thereby
canceling accrued interest and some principal.
Debt Suspension Agreement (also Debt Deferment Agreement)
The accrued interest is cancelled and the loan balance is
frozen when a protected event occurs. Once the protected
event ends, the borrower will start repaying his or her
loan from where they left off. This essentially extends
the term of the loan without increasing the amount owed
and without suffering any penalty on their credit report
or score.
Payment holiday The contractual requirement to make a loan
payment is waived. However, interest continues to accrue
and no portion of the principal balance is cancelled,
which then extends the loan term and increases the
balance. The principal benefit of this low-cost product
feature is that it protects against loan delinquency, thus
protecting the member's credit rating.
Critical period benefits The benefits are limited to a
maximum duration, or critical period, as defined in the
debt protection product. For example, disability benefits
may be limited to a maximum of 12 months. This approach
provides benefits when they are most needed at a
significantly reduced cost compared to credit disability
insurance that provides a benefit for the remaining loan
term.
Percentage wise, a borrower's chance of having a
triggering event occur during the term of the loan is very
low. Paying for the privilege of possibly suspending
payments at some point in the future is not a good value.
IF one is determined to purchase on some sort of
protection, buy credit insurance, which makes the
payments, and do not buy into debt suspension or debt
cancellation agreements.
Lenders are starting to tailor their debt protection
products to the markets they serve. Many sub-prime
borrowers might feel more pressure to purchase these
products, thinking it might positively influence the
initial lending decision. The same is true with many
sub-prime borrowers who are attempting to obtain a credit
card, perhaps their first, perhaps their first after a
bankruptcy.
The offer for credit protection is more prominent in the
new card offers than the universal default clause, both of
which should be avoided. It is another good reason why
these types of fee-based, expensive credit offers with
lots of conditions, hurtful to borrowers, should be first
rejected and then shredded.