If you need to borrow money, using your life insurance as collateral could be a useful tool to help you secure funding.
There are many different types of loans to choose from when large expenses arise, but they generally fall into two categories: secured and unsecured loans. While secured loans may carry advantages like better rates and a higher chance of getting approved, they come with one major stipulation: you will need to provide a form of collateral. You could choose to use your vehicle or even your home as collateral, but doing so comes with high risk: if you cannot make the loan repayments, you could lose your car or house.
Instead of taking these risks, your life insurance policy may be a good option for collateral, if your lender will accept it.
What is collateral assignment of life insurance?
A collateral assignment of life insurance is a method of securing a loan by using a life insurance policy as collateral. If you pass away before the loan is repaid, the lender can collect the outstanding loan balance from the death benefit of your life insurance policy. Any remaining funds from the death benefit would then be disbursed to the policy’s designated beneficiary(ies).
Why use life insurance as collateral?
There are several reasons why you might want to use life insurance as collateral for a loan. Among them:
- It can be affordable. Depending on your age, health, the type and value of policy, life insurance costs vary. However, life insurance premiums may be less than what you would pay for an unsecured loan with higher interest rates.
- You are not jeopardizing your personal property. By using life insurance as collateral, you might be able to take out a secured loan without putting your home or vehicle at risk. If you pass away before the loan is repaid, the lender will use funds available from your life insurance policy’s death benefit to pay off the loan.
- It may be attractive to lenders. Many financial institutions view life insurance as a good option for collateral, knowing that they will very likely have the money to pay off your loan in the event of your death.
Of course, there are also some situations in which a collateral assignment of life insurance is not the best option. Some people are unable to obtain affordable life insurance due to their age or health complications. It can also be difficult to use an existing life insurance policy as collateral for a loan; a lender may require you to take out a new policy, specifically for the purpose of the collateral assignment.
Alternatives to life insurance as collateral
If you are considering a collateral assignment of life insurance, there are a few alternative funding options that might be worth exploring. Since many factors determine each option, working with a financial advisor may be the best way to find the ideal solution for your situation.
Depending on your situation, an unsecured loan may be more affordable than a secured loan with life insurance as collateral. This is more likely to be the case if you have good enough credit to qualify for a low interest rate without having to offer any type of collateral. There are many different types of unsecured loans, including credit cards and personal loans.
Cash value life insurance
Some life insurance policies accumulate cash value over time that you can use in different ways. If you have such a policy, you may be able to partially withdraw the cash value or take a loan against your cash value. However, there are implications to using the cash value in your life insurance policy, so be sure to discuss this solution with a life insurance agent or your financial advisor before making a decision.
Home equity line of credit (HELOC)
A home equity line of credit (HELOC), is a more flexible way to access funds than a standard secured loan. While HELOCs carry the downside of risking your home as collateral, you retain more control over the amount you borrow. Instead of receiving one lump sum, you will have access to a line of credit that you can withdraw from as needed. You will only have to pay interest on the actual amount borrowed.
Frequently asked questions
How do I take out a loan using a collateral assignment of life insurance?
If you would like to take out a loan using life insurance as collateral, your first step should be to find a lender willing to issue this type of loan. After you confirm the lender’s requirements, you may be able to use your existing life insurance policy (if the lender will allow it) or will need to purchase a new policy for a collateral assignment.
If you take out a new policy, the application process is the same as applying for any other type of life insurance and may require extensive underwriting, including a medical exam. After you have purchased the new policy, you will need to ask the insurance company for a collateral assignment form that you will need to complete, noting your lender as an assignee. Generally, a lender will not be listed as a beneficiary. The beneficiary(ies)will be the person you would like to receive any leftover benefits not claimed by the lender.
What types of life insurance can I use as collateral for a loan?
Any type of life insurance policy can be used to secure a loan. This includes term, traditional whole life, universal life and variable universal life, according to the Insurance Information Institute. However, each financial institution will likely have different requirements. Make sure to discuss these requirements with your lender before purchasing life insurance with the specific intention to use it as collateral. If more than one option is available, you may want to compare the cost of premiums for each type of policy.