Mind Your Decisions

Should You Get a Credit Card Payment Protection Plan?

source: mujitra via flickr

Credit card payment protection plans offer relief when you are out of work or sick. Your entire balance may be waived, for instance, in one of these emergencies. The cost is usually a percentage of your monthly balance, on the order of 1 to 2 percent. With a 1 percent fee, for example, you would pay $1 for every $100 charged. There is no fee if you don’t charge anything.

Is this plan worth doing?

I needed to make this decision earlier in the week. Ideally, I would have researched the facts and made an informed decision. But the circumstances were against me.

I was in a store and I didn’t have internet access. Even if I did, I didn’t have the time to research because I was holding up the line. I didn’t like it, but I had to make a gut call.

When faced with new situations, experts make comparisons to the familiar. Managers think about similar Harvard case studies. Coaches study film on their opponents.

Treat my analysis in a similar vein—as an educated guess based on my experience.

I had about 30 seconds to think, so I relied on my three-step decision framework:

1. Think strategically
2. Run the numbers
3. Think about risk

Think strategically

This is the most powerful step you can take when analyzing any financial offer. What are the incentives of the person selling?

I thought about a similar situation: long-term disability insurance at work. This is a case where insurance will cover a large portion of your salary if you get sick. It makes perfect sense why a company would offer this plan—they want to develop enduring relationships with productive employees.

I didn’t see the same symbiotic relationship with credit card companies. They might care more about short-term profit, as payments off of high interest rates line their pockets. What is their stake in relieving the debt from an individual customer? It sounded fishy to me on a strategic level.

Run the numbers

The plan had a 1.5 percent fee for the monthly balance. If I charged about $100 a month, for instance, that would cost me $1.50 x 12 = $18 a year.

That’s not a lot of money, but it would be enough to buy a modest restaurant meal.

What is the benefit? I pay my credit card each month, so when I did fall ill, I would probably have one month’s balance outstanding, about $100.

Do I really want to spend $18 a year for the expected benefit of a one-time $100 debt relief?

This doesn’t sound that appealing.

Think about risk

There is another reason the plan doesn’t make sense: I have money stored for such emergencies.

I am a big fan of “emergency funds” or “rainy-day funds” where you keep cash for unexpected expenses. Experts vary on how big this fund should be. I’ve heard ranges from the low end of $1,000 to the high end of 3 to 6 months of living expenses. (Here is a good article from Wisebread.)

I am on the conservative side and use an online-savings account for my short-term funds. I certainly would have enough to cover a $100 balance even if I went ill or lost my job.

Impression: Plans are not worth it

The costs are hard to justify. The benefits don’t seem overwhelming, especially if you have an emergency fund.

There was one more compelling reason not to sign up right away: it would have been an unnecessary commitment.

When companies offer additional services, you can almost always sign up for them later. If you commit early, you risk forgetting about it and losing money until you cancel. If you wait until you might reasonably need it, you stand a better chance of following through and having it when you need it.

You’ve heard my thoughts and now I want to hear yours. What’s your take on credit card payment protection plans? Has anyone signed up and found it useful?

If you’re come across or written an article on this topic, feel free to add a link in the comments. I want to add an appendix with the full research.