Does it make sense to use your life insurance as collateral for a loan?

collateral assignment of life insurance

The assignment of warranty allows 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’s how collateral assignment loans work, along with the pros and cons and alternatives to collateral assignment. For more help with loans or life insurance, consider work with a financial advisor.

What is a life insurance collateral assignment?

When you apply for a loan, such as a business loan, the lender may require collateral before approving the loan. One way to provide security for the loan is to use your life insurance policy. If you die before you have fully repaid the loan, the policy death benefit will pay your lender first. Then the 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 purchase a new policy that can be used as collateral. The lender will be listed as the assignee on the collateral assignment form, which is different from listing the lender as a beneficiary of the policy.

Lenders are often willing to accept this type of arrangement because the money is guaranteed if the borrower defaults or dies before the loan is repaid. To use your life insurance as collateral, you will need to apply for collateral on your new or existing policy.

How to make a warranty transfer request

collateral assignment of life insurance

collateral assignment of life insurance

If your loan requires collateral, there are a few basic steps you need to take to use your life insurance as collateral. We will describe these steps here. First, 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 current policy is insufficient, you may need a new life insurance policy; if so, make sure the new policy passes both checks.

Once you have your policy that you can use as collateral, you must complete a collateral assignment form. You will indicate your lender as assignee of the death benefit. You and your lender will need to assign the form to give your approval. At this point, your bank should be able to confirm the collateral assignment and you can apply for your new loan.

Benefits of Collateral Assignment

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 risk to your personal property: Many people’s most valuable assets are their homes and vehicles, which can make them work as collateral. The problem is that the lender could seize them if you default or die before a loan is reimbursed.

  • Cheap alternative to personal loans: Life insurance rates vary depending on many factors such as your age and health. However, if your policy has low premiums, it might be cheaper than taking out a personal loan.

  • Access the financing you need: If a lender asks for collateral, they just want something that can recover lost loan income. If your life insurance meets this requirement, your lender should be prepared to accept it.

Disadvantages of collateral benefits

There are, as with any financial choice, potential downsides:

  • May reduce death benefit for beneficiaries: If you indicate your lender as assignee on the collateral assignment form, they will be paid before your assignees, if applicable. If you have a whole life policy with monetary value, it may be enough to cover the cost of the loan. Otherwise, the death benefit of your beneficiaries could be reduced.

  • May require a new policy: Your insurer may not allow you to use your existing policy as coverage. If so, you may need to buy a new font if you still want to go that route.

Possible alternatives

collateral assignment of life insurance

collateral assignment of life insurance

There are alternatives to collateralizing life insurance that you may want to consider. In addition to the disadvantages of this arrangement, you may want to reserve your life insurance for other purposes, such as paying off debt.

  • Home equity line of credit: If you are a homeowner and have equity, you might consider borrowing against that equity. However, this puts you at risk of losing your home.

  • Unsecured loan: Another alternative is a unsecured loan. However, if a lender required collateral, it likely means that an unsecured loan would come with unfavorable terms, such as high rates. So, this option is best if you have good to excellent credit.

  • life insurance loan: As mentioned earlier, some life insurance policies have a cash value. If you’ve built enough cash value into your policy, you can borrow against it. But any unpaid amount will be deducted from your death benefit – plus interest.

  • Policy cashing: It is possible in certain cases to cash in a life insurance policy, after deducting certain costs. But this means that your existing life insurance policy will be terminated and you will have to find a new one.

The essential

Collateralizing life insurance allows you to use your life insurance policy as collateral when applying for a loan. 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 warranty requirements. Using your life insurance policy comes with some benefits, like not risking your personal assets. But it also has downsides, like requiring a new policy in some cases. Consult a financial adviser before making important financial decisions.

Tips for buying life insurance

  • Deciding how much life insurance to buy is not easy, especially with so many things to consider. Smart Assets life insurance calculator can help you estimate the amount of life insurance you need in your particular situation.

  • A financial advisor can guide you through important financial decisions, such as buying life insurance. SmartAsset’s free tool connects you with up to three financial advisors who serve your area, and you can interview your advisors at no cost to decide which one is best for you. If you’re ready to find an advisor who can help you achieve your financial goals, start now.

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