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Collateral assignment of life insurance

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    Article Highlights

    If you need to take out a loan for any reason, your lender may require that you supply some form of collateral before you are approved. In most cases, this could be any type of asset, such as a savings account, IRA or employer-sponsored retirement plan or even a tangible asset, such as your home or car. However, you may be unaware that you can use life insurance policies as collateral, in some cases. In fact, life insurance can be one of the most effective forms of collateral available. 

    What is a collateral assignment of life insurance?

    A collateral assignment of life insurance occurs when an insured uses their insurance policy as collateral for a loan. If the insured dies while the policy is in force, some or all of the death benefit may be used to pay off the loan that the insured took out. Life insurance makes for good collateral because the lender knows that they will be repaid if the borrower dies. 

    Permanent life insurance policies are typically the ones that are used for loan collateral because of their cash value. While term life insurance can be used to pay off a debt if the insured dies, it has no inherent tangible economic value on its own, while the insured is still living. If the insured becomes unable to make the payments on a permanent policy, then they can just cash the policy in and collect the remaining cash value after all policy loans and expenses have been repaid. 

    How to apply for life insurance for collateral assignment

    The process for applying for a loan using the cash value in your life insurance policy is much like the process for applying for any other type of loan. If you take out a car loan, your car will serve as the collateral. If you take out a mortgage, then your home is the collateral. Similarly, when you apply for a loan using your cash value life insurance policy, then the cash value serves as your collateral. 

    The assignment process 

    The key difference with using your life insurance policy as collateral is that you will not name the lender as a beneficiary on the policy, because then the lender would get some or all of your death benefit even if you have already paid off the loan. Instead, you will name the lender as an assignee on the policy, and you will serve as the assignor. 

    The life insurance company will supply you with all of the paperwork necessary to accomplish this, but first you have to get permission from your life insurance carrier to use the policy as collateral. Once you have that, you can tell the lender that they can move forward with the underwriting process. Then your loan will either be approved or denied. 

    It should be noted that there is no rule requiring either the borrower or the lender to use a set of standardized documents to create an assignment. This type of assignment can be creatively constructed by either or both parties and does not have to be approved by the life insurance company. 

    Current vs. new policies 

    Some lenders will accept a current policy that you have as collateral, while other lenders may require you to take out a new policy for this purpose. If the latter is the case for you, be sure to notify the insurance company that you’ll be using the policy for collateral. Collateral assignment is legally considered to be a limited transfer, which means that the lender will only be repaid from the cash value in the policy if you default on the loan.  

    How to name beneficiaries when applying for life insurance for collateral assignment

    You should name the same beneficiaries that you would name if the policy was not collateralized. For example, if you want your kids to get the death benefit from your policy, then you would still name them as equal co-beneficiaries (or however else you want the death benefit to be distributed). If you die before you have repaid the loan in full, then the lender — as the assignee — will get back the outstanding loan balance and the remainder of the death benefit will be distributed according to your wishes. 

    Who owns life insurance for collateral assignment?

    You must always be the owner of the life insurance policy in a collateral assignment. If you and your spouse jointly own the policy, then you must both be listed as the co-assignors. You also have to keep the policy in force by making the premium payments on time, which ensures your collateral does not expire. In many cases, the lender will require you to send duplicate statements and other notices from the insurance company to them so that they will be notified if you have failed to pay your premiums or the policy is otherwise in danger of being cancelled. If you become unable to pay the premiums for a period of time, the lender may step in and make them for you, but they will usually add these payments to the outstanding balance on your loan. 

    When to fill out collateral assignment paperwork

    You will need to complete the assignment paperwork at the same time that you apply for your loan. Many lenders will give small business owners money when a collateral assignment of life insurance is used. As mentioned previously, your life insurance company will be able to provide you with all of the necessary paperwork to assign your policy to the lender. Or you and/or the lender can draw up an original assignment, if you both agree to the terms. 

    When does collateral assignment end?

    The collateral assignment that you make to the lender becomes null and void once you have repaid your loan. At that point the lender no longer has any legal claim on you, and you are free and clear of any prior obligation to assign your policy. In order to do this, you and the lender will both sign forms supplied by the insurance company rescinding the assignment. Once the insurance company receives these documents, you become the sole owner of your policy once again. 

    Alternatives to collateral assignment

    If you do not like the idea of having a lender having visibility into your life insurance policy, you have a few alternatives, including:

    • Using the cash value in your policy directly – Instead of assigning your cash value, just withdraw it and use it as you need to.
    • Taking out an unsecured loan – This will cost more than a collateralized loan, but your policy is not at risk this way.
    • Taking out a home equity loan – You may be more comfortable with this type of loan than one that uses your life insurance as collateral.

    The Takeaway

    • Collateralized life insurance is using your life policy as collateral for a loan.
    • You should name the lender as an assignee, not a beneficiary.
    • You can use pre-printed standardized forms for this or create your own agreement.
    • The assignment is rescinded once you have repaid the loan.

    Using your life insurance policy as collateral can be a good way to leverage one of your most valuable assets in order to obtain financing. Just be sure that your beneficiaries understand what will happen if you die before you repay your loan and make sure that the lender is an assignee and not a beneficiary. Consult your financial advisor or life insurance agent for more information on collateralizing your life insurance policy and what this could do for you.

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