Most consumers perceive life insurance to be a product that simply covers their expenses on behalf of a loved one in the event of an untimely death. Indeed, that’s how most life insurance products are sold online and through television commercials. While that’s a great reason to purchase life insurance, and a financially responsible decision that will benefit several family members, it’s not the only way that life insurance is used to eliminate the possibility of financial losses.

Many banks require consumers to take out a term life insurance policy when they request a personal loan or a business loan from that institution. The life insurance policy is used as a way of securing the loan, ensuring that the bank will have the full amount of the loan repaid in the event of the borrower’s death. Without such a policy, banks expose themselves the possibility of a major financial loss if their borrower passes away before the full repayment of the loan amount.

How it Works: The Bank Has a Financial Interest in the Consumer

Life insurance policies can only be sold to cover someone that consumers have a vested financial interest in. For example, a spouse can take life insurance out on her husband. Parents can take life insurance policies out on their children, as well, in most cases. These are the most common ways to pursue a life insurance policy, but they’re not the only ones.

When a consumer takes out a loan from their local bank or small business administration, that bank (or SBA) immediately has a financial interest in the consumer’s well-being and financial health. In many cases, especially large loans must be guaranteed by a life insurance company so that the bank doesn’t stand to lose the full balance of the loan upon the borrower’s death. This is because many estates can be structured to actually avoid repayment of loans and other financial obligations if the borrower passes away unexpectedly. Without any form of guarantee, the bank could suffer a pretty dramatic loss on its balance sheets.

The Cost: A Relatively Minor Added Expense for Most Borrowers

The good thing about life insurance for bank loans is that the cost of the policy is relatively insignificant when compared to the amount of money being loaned to the borrower by the bank. Typically, only very large loans, like those in the tens of thousands of dollars, require such coverage. As part of the bank’s commitment to simplicity for its borrowers, many financial institutions will actually bundle the cost of the life insurance policy with the loan itself, treating it like accrued interest over the term of the loan.

Consumers will have to sign a few documents indicating that they do wish to purchase the term life insurance product and bundle it with their loan. If they decline this provision of the bank’s loan contract, they will have to either get a term life insurance policy on their own and forward documentation to the bank, or simply decline the loan offer in the hope of finding a local bank without the term life requirement.

Consumers Should Prefer a Term Life Insurance Product with Bank Loans

Much of the focus on term life insurance for bank loans has been directed toward the bank’s interest in the borrower’s well-being, but it’s worth noting that borrowers have a stake in the process as well. Were the borrower to pass away unexpectedly, their surviving loved ones may be responsible for the full balance of the loan that remains outstanding. While many estates are structured to avoid such a scenario, many others are not.

For the sake of a family’s long-term fiscal health, it’s a good idea not to go the less expensive route by avoiding term life insurance coverage to secure a large loan. Banks may push these products as a way of protecting themselves, but they remain a viable choice during lending because many consumers simply have a strong interest in protecting their families from inherited debt loads, vicious bank creditors, and a cycle of financial distress that does them a great disservice.

A Small Cost with Big Rewards for Both Sides

In all likelihood, consumers will far outlive the term of their next large bank loan. That’s not guaranteed, though. With a strong term life insurance product bundled with the loan, or purchased separately, banks and borrowers can be protected from mutual financial loss that might otherwise have disastrous consequences. It’s hard to argue with that kind of long-term peace of mind.