Payment protection insurance sounds pretty good when it’s being sold to you by a commissioned salesman from your credit card company. Some companies charge a fee around 1% of the outstanding monthly debt on your credit card (plus your minimum payment amount) for the service. In return, you’ll receive waivers for payment obligations if you ever become sick, unemployed or unable to afford payments. Each credit card company has different terms, but some offer 2 years of waived minimum payments in the event that you lose your job or sustain debilitating injuries.One percent doesn’t sound like much in the overall scheme of things, and in return you’ll likely avoid enormous late fees.
What exactly are you paying for?
Before you sign up for payment protection insurance from your credit card company, you should first consider a couple of things. The first thing that should be questioned is the nature of the debt that you’re trying to insure. It isn’t secured. Unlike with car notes, mortgages and other types of secured debt that have tangible assets as collateral, your credit card debt doesn’t have anything that your creditor can seize.
The first creditors to be paid when someone goes bankrupt or has to otherwise restructure their debts are secured creditors. After they have been fully paid, the non-secured creditors are paid with whatever is left. So if you were to face serious problems, there’s a good chance your credit card companies might never get paid.
For this reason, card issuers to be more flexible. So say you were making payments on time for two years, then suddenly lose your job. It is likely that your credit card company will cut you some slack, giving you a little leeway in your payment obligations for a few months. This is done for their best interest and yours. By giving you amnesty, it saves them from having to write off your whole balance later on.
Weighing in the Costs
Another thing you will have to consider is the price for the payment protection. It’s 1%, which doesn’t sound like much, but it’s 1% per month, or about 12% annually if you keep a constant balance. Unless yours is a low interest credit card, you’re likely facing 15% or more in interest already. So with payment protection insurance, your rate will be closer to 27%.
Let’s put it in a more mathematical form. Imagine you have a $1,000 balance on your credit card. With most credit card companies, you are required to pay a minimum of 2% monthly, which would be $20 in your case. With payment protection, you’ll be paying an additional $10 for each payment, making it $30. Over a five year period, you’ll end up paying an additional $600 that you could have pocketed. If your balance goes any higher, it would end up being even more than that, and if you have a lower balance, it would be less.
Then what’s worse is that this $600 isn’t even being placed towards your card’s principal. It’s just like other types of insurance where you only benefit from it in the event of an emergency. Plus you can still be charged interest on the protection fees. Although you will have waived payments for a couple of months, keep in mind that you still have debt and it will continue to accumulate interest during the time that you’re not making payments. This will put you in a worse situation than you were in before.
So before signing up for payment protection for your credit card, make sure that you think twice about how much it’s costing you, and what you really get in return. The money spent on that could be used towards other things, like an emergency savings account. Or you could apply that money towards getting rid of your balance altogether. Keep in mind that there’s no better payment protection than to be debt-free.