Academic journal article ABA Banking Journal

Debt Cancellation: The Preferred Alternative to Credit Insurance

Academic journal article ABA Banking Journal

Debt Cancellation: The Preferred Alternative to Credit Insurance

Article excerpt

Credit insurance products offered by U.S. lenders have seen better days. Since the first policy was sold in 1917, credit insurance has been routinely offered in conjunction with consumer installment debt. For decades, credit insurance has also been offered to protect credit card balances. Over time, millions of people have purchased this optional protection from their lender.

Today, credit insurance is in the decline mode of its business life cycle. Lenders are abandoning their credit insurance product and no longer offering it on certain types of loans. Some find it difficult to keep pace with the myriad of changing insurance regulations. Others are frustrated with the resulting interstate inconsistencies in product, price, and eligibility provided to their customer base. Simply stated; the product is worn-out!

Many lenders are looking for an alternative to a credit insurance product. And they are finding one based on something called a debt cancellation agreement. What follows is a practical guide to understanding this growing alternative.

What is Debt Cancellation?

In simple terms, a debt cancellation agreement may do one or more of the following:

* cancel the debt or monthly payments

* defer payment on existing debt (typically referred to as debt deferment or debt suspension)

Most lenders in the U.S. are authorized to offer a debt cancellation agreement to the lending customer. The three basic components of any such agreement involve: amending the lending agreement, charging a fee, and canceling the debt upon death, disability, involuntary unemployment, or other defined life events.

You will find variations of debt cancellation, which are called debt "deferment" or debt "suspension". For this document, we will use the term "debt cancellation" to encompass the product variations of debt deferment, debt suspension and the like. While each program is different and terminology may vary somewhat, the end results of a given program are clear:

* If a lump sum benefit is provided, the outstanding balance is cancelled

* If a monthly benefit is provided, features may include: canceling the entire monthly payment, canceling only the interest for the month, or canceling the interest as well as reducing the principal loan balance.

Actual programs offered by today's lenders often use combinations of the above. Some programs forgive the outstanding balance while others forgive monthly payments for a period of time. Some programs defer a monthly payment requirement and stop accruing interest during the benefit period. With any type of debt cancellation agreement, the lender does not have to eliminate the entire debt--the lender may cancel a set amount, cancel a percentage, or cancel after a set period of time. While having many choices in product design may seem a bit overwhelming, it is what makes debt cancellation such an excellent alternative to credit insurance. Once a lender defines the product that makes sense for their lending situation and customer base, they can then offer a single, consistent product to all customers, in all places throughout the U.S.

To understand the simplicity of debt cancellation, it is helpful to compare it to traditional credit insurance products still offered today.

While there are many differences between credit insurance and debt cancellation products, there are three important similarities. Like credit insurance, a debt cancellation agreement is offered to the customer as an option--this form of protection like credit insurance is optional and must be clearly disclosed as such. Further, debt cancellation agreements must abide by Regulation Z disclosure requirements. And finally, customers receiving benefits from either credit insurance or a debt cancellation agreement, should consult their tax advisor regarding federal and/or state tax implications of benefits.

As part of a lenders "information return reporting" or form 1099 requirement, you should find that for both credit life and disability benefits as well as like debt cancellation benefits, do not require you to file a form 1099 for the benefit provided to your customer. …

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