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Don't waste money on coverage that may leave loved ones without the funds they require.

Key points

  • Life insurance is important to offer financial security to surviving dependents in case of an untimely death.
  • Not all types of life insurance offer this security.
  • Dave Ramsey warned that mortgage life and credit life insurance policies don't provide the financial help many families require.

Life insurance exists to offer peace-of-mind and to ensure loved ones don't face a financial shortfall if an untimely death occurs. But not all policies offer the necessary protection from a money crisis.

In fact, finance guru Dave Ramsey warns that purchasing one particular type of life insurance could leave families with "very little financial security" in the end. Here's why.

This coverage offers too little protection

The type of life insurance Ramsey warns against is mortgage life and credit life insurance. These types of policies are classified as "decreasing term" policies. Here's how they work, according to Ramsey.

"As you pay your debts down, your death benefit goes down too. Specific examples of this type of insurance include mortgage life and credit life insurance. In these examples, the death benefit is designed to follow the amortization schedule of a mortgage or other personal loan," the Ramsey Solutions blog explains.

Basically, what happens is, the insurer agrees to pay off the remaining balance of any credit card debt or mortgage debt that the deceased person owed upon their death. As Ramsey said, "The policies are advertised as a way to settle debts or pay off your mortgage if you die."

Why won't these policies suffice?

First, it's impossible to know how much will be owed on these loans at the time of death. So, there's no way to plan how much the policy will pay out. "You never know how much they're going to be worth when you die, so they provide your family very little financial security," Ramsey said.

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Second, since these policies only pay off the remaining loan balance, they do not offer any other type of financial assistance to surviving dependents. Those who are left behind "potentially inherit nothing more than a paid-off or paid-down debt, but no cash in their pocket," Ramsey warned.

Many people need additional money to cover funeral costs or to replace income the deceased was earning prior to passing on. While having a mortgage or credit card bills paid down may help them a little bit, this won't assist them with the final burial expenses or with covering their other bills such as paying for childcare or groceries once they are no longer getting support from the deceased person.

Should consumers listen to Ramsey and steer clear?

Ramsey is right that buying decreasing term life insurance makes little sense for most people. Instead, it's smarter to buy a term life insurance policy.

Term life policies pay out a death benefit and policyholders can decide how large that death benefit should be. The policyholder can choose to get enough coverage that the payout will be enough to repay debt in full and still leave plenty of cash left over for other things.

So, not only will a term life plan ensure no debt is left over -- just as mortgage and credit insurance does -- but it can also offer additional coverage. And a term life policy usually comes at a much better cost than decreasing term coverage.

In this case, listening to Ramsey is definitely a smart move.

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About the Author

Christy Bieber is a personal finance and legal writer with more than a decade of experience. Her work has been featured on major outlets including MSN Money, CNBC, and USA Today.

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