Need a loan but worried about having collateral to back it up? Consider a source you haven’t thought about yet – your life insurance policy.
Collateral assignment of life insurance lets you use a life insurance policy as an asset to secure a loan. If you die while the policy is in place and still owe money on the loan, the death benefit goes to pay off the remaining debt. Any money remaining goes to your beneficiaries.
Why go this route? Most people purchase life insurance to protect their loved ones at the time of their death. By using a life insurance product as collateral, you can tap into its value while you’re still living. You can use your plan as collateral for various types of loans, including mortgages or a business loan. Let’s see how this may help you.
What is a collateral assignment of a life insurance policy?
With collateral assignment of life insurance, ownership of an asset transfers from the borrower to the lender. This transfer only remains in place until the loan is paid in full.
In this situation, the transferred asset is your life insurance policy. The goal is only to satisfy your loan obligation. Once that debt is repaid, you’ll end the collateral assignment.
You can use a term or permanent life insurance policy as collateral for a loan, although more lenders may accept a permanent policy. Here’s how each works:
- Term life: Term life lasts for a set number of years and provides a payout if you die while the policy is active, so a policy can protect your lender if you die before repaying the debt. Lenders typically only accept term plans as collateral that last at least as long as the loan term..
- Permanent life: A permanent policy lasts for your entire life and also builds cash value over time. As the collateral assignee of life insurance, the lender may collect a portion of the death benefit to repay your debt or take the accumulated cash value in the policy if you stop making payments.
One key thing to remember about collateral assignment life insurance is that there are consequences if you fail to pay back the loan. The lender may take over your policy if you stop making payments to recover the money they lent to you. Not all collateral assignments allow for this, though.
How is a collateral assignment used? Here’s an example:
Let’s say you have a great business idea. You need a loan of $50,000 to get your business started. When you apply for the money, the bank wants collateral to back up the loan, just in case. A life insurance policy with a cash value of $75,000 and a death benefit of $500,000 may help convince them to provide the loan to you. Using collateral assignment of the policy, you allow the insurance company to pay the lender should you default on the loan, or you die before you repay it.
What are the pros and cons of using life insurance as collateral?
Using life insurance as collateral for a loan can provide you with the asset you need to fund your business or personal goals, like buying a home or starting a business. However, the biggest risk is losing your life insurance policy if you default on the loan.
To minimize these risks, some alternatives to a collateral assignment include:
- Borrowing from your life insurance policy. If you have a cash value life insurance policy that has built up cash value, you could borrow from it with a low-cost loan. This may reduce your costs and eliminate the need to work with a lender at all.
- Surrendering your policy. Do you have a life insurance policy that you may not need? If so, surrender the policy to gain access to the cash value. In this case, however, your beneficiaries will no longer receive the death benefit.
- Finding other loan options. This may include using a co-signer to secure the loan. Or, use another asset, like your home’s equity, to back up the value of the loan.
How to make a collateral assignment in life insurance
Not sure where to start with a collateral assignment? Here’s a brief look at the process.
- Apply for life insurance, receive approval, and then designate your primary and secondary beneficiaries as normal.
- Fill out a collateral assignment form from the life insurance provider. You can also contact your agent to find out how to obtain this form.
- Both you and the collateral assignee (the lender) sign the document. Additional documentation may be necessary. The form provides all steps involved.
- Submit the form as instructed. There’s a review of the document and processing to set it up.
- Receive a letter acknowledging the agreement. The lender receives one as well.
Wondering if collateral assignment is the right option for you?
Get help from our Fidelity Life team. Our agents are here to answer questions and help make sure your life insurance provides financial support each step of the way.
At Fidelity Life, our goal is to make life insurance simple, affordable, and understandable for everyday families. This content is intended for educational purposes only. Each post is carefully fact-checked, reviewed, and updated regularly to ensure the information is as relevant as possible.