I was chatting with a friend recently who informed me that he once signed up for a balance protection offer from his credit card company. You’ve probably been offered this at some point. Someone calling on behalf of your credit card company will offer you a service that will pay your minimum payment owing every month if you lose your job, become disabled, or whatever. The cost is around $1/month per $100 owing.
What They Don’t Make Clear About Credit Card Balance Protection Insurance
I think most people would believe that, after hearing the pitch on the phone, that if they paid their balance off in full every month there would be no need for the insurance, and no cost either. Some would sign up thinking that if something DID happen between payments that caused one to be unable to generate an income, then whatever small payments owed at that time would be covered for little cost. So people who don’t carry a balance month to month might actually sign up for this offer.
Unfortunately, that’s not how it works. The cost is calculated on your average daily balance owing on your card. This means that even if you paid your card off in full every month, you would still be paying for this insurance.
Example Calculation
Let’s say that on the first day of your billing cycle you spend $1000 for automatic payments (maybe you funnel all your regular monthly payments through your credit card). Thirty days later you pay off your card in full by the payment due date. Your average daily balance is going to be $1000 x 29 days/30 days which equals $966.67. Now they will calculate your insurance premium based on this number. In this case it would be $9.67/month.
So for those who pay off their credit card in full every month and think they don’t pay credit card interest but have this “balance protection” insurance, think again. Your effective interest rate is about 12% per year (effectively). If you carry a balance and DO pay your regular interest rate on the balance owing AND you have this balance protector insurance, it’s like adding 12% to the interest rate you thought you were paying.
As an extreme example, for those who carry a credit card balance on a high interest rate card of 19.9% – you’re actually paying closer to 31.9%. Yikes!
Moral Of The Story
If you have your finances in order (i.e. you have disability insurance, emergency reserve, etc.) you’ll never need balance protection insurance.
Well said. I would have a hard time sticking to the facts rather than saying what I think of sellers of credit card insurance.
It took quite a bit of restraint to say what I really thought… :)
Of course they need premiums to cover their risk. If someone is irresponsible enough to sign up for balance protection insurance who knows what other decisions they'll make :)
Highlights the fact that the best way to insure any debt (credit card, insurance) is through proper financial planning principals (adequate DI, CI, life insurance as well as “rainy day account”).
Thanks Preet!
I just canceled my balance protection. What a battle ! The credit card company really tried to make it sound like I was making a huge mistake. They required me to listen to a bunch of legal disclaimers before the balance protection would be removed.