What is collateral assignment of life insurance?

How does collateral assignment of life insurance work?

If you die before fully repaying your loan, collateral assignment will allow the lender, or "assignee," to be repaid for the outstanding loan amount using your death benefit. If you pay back your loan fully before passing away, or if only a portion of your death benefit is needed to pay off your loan, your beneficiaries can still file a claim for the policy's death benefit.

What types of life insurance are eligible for collateral assignment?

Both term and permanent life insurance policies may be used as collateral, though some lenders may not accept term life policies since they don't have cash value. Using a cash value life insurance policy as collateral allows your lender to access the cash value, which providers an additional safeguard in case you default on your loan.

Additionally, some types of permanent life insurance may not be accepted by your lender, such as final expense insurance. Since these types of policies tend to have lower coverage amounts, it's possible your policy may not be worth enough to secure a loan (depending on how much you're trying to borrow).

What steps are required to apply for collateral assignment of life insurance?

Depending on your lender and the loan type and amount you're applying for, collateral assignment of your existing life insurance or a new life insurance policy may be required. Collateral assignment requirements are particularly common with business loans. Here's how to apply for collateral assignment of life insurance:

Will collateral assignment affect my beneficiaries?

With collateral assignment, you should still name beneficiaries as usual, but the total death benefit available to them will depend on when you pay off your loan. If you pay it off before you pass away, your death benefit won't be affected. However, if you pass away before paying off your loan, the total death benefit your beneficiaries can file a claim for will be reduced by the amount needed to fully pay back your lender.

Your lender will be an assignee rather than a beneficiary, and the assignee can only claim up to the amount required to settle your loan. Any amount remaining may be claimed by your beneficiaries, so be sure to update your beneficiaries as needed while your policy is active.

When does collateral assignment of life insurance make sense to do?

Collateral assignment of your life insurance policy may make sense if you're shopping for a secured loan and don't want to put up your house, car, or other personal property as collateral. Secured loans tend to have lower interest rates than unsecured loans (loans that don't include collateral), so you can borrow money for less. It can be an easier way to secure funding to start a business or pay for major expenses (such as hospital bills).

Other ways life insurance can help you with a loan

Collateral assignment might not be the only way to qualify for the loan you need. If you have a whole life or universal life policy, consider how much cash value it currently has. Instead of borrowing from a lender, you may be able to borrow from your policy's cash value via a life insurance loan. Note that there will be limits to how much you can borrow without putting your coverage in jeopardy, and any part of the loan not repaid by the time you pass away may be deducted from your death benefit.

You can also choose to cash out your life insurance policy. This would end your coverage, and taxes and fees will apply, but you could use the policy's value to eliminate your need for a loan or reduce the amount you need to borrow. Consult with a financial advisor to understand the implications of your particular situation.