Collateral assignment enables you to use your life insurance as collateral for a loan. This allows you to be approved for a loan if you don’t want to put your other assets at risk. Here is how collateral assignment loans work, as well as the pros and cons and alternatives to collateral assignment. For more help with loans or life insurance, consider working with a financial advisor.
What Is a Collateral Assignment of Life Insurance?
When you apply for a loan, such as a business loan, the lender might require collateral before approving the loan. One way to provide collateral for the loan is to use your life insurance policy. If you die before fully repaying the loan, the policy’s death benefit will reimburse your lender first. Then, any remaining funds will go to your beneficiaries.
Not all lenders will allow you to use your life insurance as collateral, and if they do, they may require you to buy a new policy that can be used for collateral. The lender will be listed as an assignee on the collateral assignment form, which is different from indicating the lender as a beneficiary on the policy.
Lenders are often willing to accept this kind of arrangement because money is guaranteed if the borrower defaults or dies before the loan is repaid. To use your life insurance as collateral, you will have to apply for collateral on your new or existing policy.
How to Apply for Collateral Assignment
If your loan requires collateral, there are a few basic steps you must complete to use your life insurance as collateral. We’ll outline those steps here. Firstly, check to see if your existing policy allows collateral assignment and if the policy’s death benefit is sufficient to cover the collateral requirements of the loan. If your existing policy comes up short, you may need a new life insurance policy; if so, make sure the new policy passes both checks.
Once you have your policy you can use for collateral, you must fill out a collateral assignment form. There, you will indicate your lender as the assignee for the death benefit. Both you and your lender will have to assign the form to provide your approval. At this point, your bank should be able to confirm the collateral assignment and you can apply for your new loan.
Collateral Assignment Benefits
If your credit isn’t the best, your lender might ask for collateral. Using your life insurance policy as collateral might be worth considering. Here are some possible reasons:
- No risking your personal assets: A lot of people’s most valuable assets are their houses and vehicles, which can make them work well as collateral. The problem is that the lender could seize them if you default or pass away before the loan is repaid.
- Cheap alternative to personal loans: Life insurance rates vary on many factors such as your age and health. However, if your policy has low premiums, it might be cheaper than taking on a personal loan.
- Gain access to the funding you need: If a lender asks for collateral, they just want something that can recoup the lost income from the loan. If your life insurance meets that requirement, your lender should be willing to accept it.
Collateral Benefit Downsides
There are, as with any financial choice, potential downsides as well:
- May reduce death benefit for beneficiaries: If you indicate your lender as assignee on the collateral assignment form, they will be paid before your beneficiaries, if necessary. If you have a whole life policy with a cash value, it may be sufficient to cover the cost of the loan. If not, your beneficiaries’ death benefit may be reduced.
- May require a new policy: Your insurer may not allow you to use your existing policy as collateral. If so, you may have to buy a new policy if you still want to go this route.
There are alternatives to a collateral assignment of life insurance that you may want to consider. In addition to the downsides of this arrangement, you may want to reserve your life insurance for other purposes, such as debt repayment.
- Home equity line of credit: If you are a homeowner and have equity in it, you could consider borrowing against that equity. However, that exposes you to the risk of losing your home.
- Unsecured loan: Another alternative is an unsecured loan. However, if one lender required collateral, it likely means an unsecured loan would come with unfavorable terms, such as high rates. Thus, this option is best if you have good to excellent credit.
- Life insurance loan: As discussed earlier, some life insurance policies have a cash value. If you have built enough of a cash value in your policy, you can borrow against it. But any unpaid amount will be deducted from your death benefit – plus interest.
- Policy cash out: It is possible in some cases to cash out a life insurance policy, less certain fees. But this means your existing life insurance policy will be terminated, and you’ll have to find a new one.
The Bottom Line
Collateral assignment of life insurance allows you to use your life insurance policy as collateral when applying for loans. This is especially common when applying for business loans. However, your insurer must allow this arrangement, and the policy must be sufficient to cover the collateral requirements. Using your life insurance policy comes with certain benefits, such as not risking your personal assets. But it also has downsides, such as requiring a new policy in some cases. Consult a financial advisor before making any major financial decisions.
Tips for Buying Life Insurance
- Deciding how much life insurance to buy isn’t easy, especially with so much to take into consideration. SmartAsset’s life insurance calculator can help you estimate how much life insurance you need in your unique situation.
- A financial advisor can guide you through major financial decisions, like buying life insurance. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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