collateral assignment of a life insurance policy

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What Is a Collateral Assignment of Life Insurance?

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Charlene Rhinehart is a CPA , CFE, chair of an Illinois CPA Society committee, and has a degree in accounting and finance from DePaul University.

A collateral assignment of life insurance is a conditional assignment appointing a lender as an assignee of a policy. Essentially, the lender has a claim to some or all of the death benefit until the loan is repaid. The death benefit is used as collateral for a loan.

The advantage to using a collateral assignee over naming the lender as a beneficiary is that you can specify that the lender is only entitled to a certain amount, namely the amount of the outstanding loan. That would allow your beneficiaries still be entitled to any remaining death benefit.

Lenders commonly require that life insurance serve as collateral for a business loan to guarantee repayment if the borrower dies or defaults. They may even require you to get a life insurance policy to be approved for a business loan.

Key Takeaways

• The borrower of a business loan using life insurance as collateral must be the policy owner, who may or may not be the insured.
• The collateral assignment helps you avoid naming a lender as a beneficiary.
• The collateral assignment may be against all or part of the policy's value.
• If any amount of the death benefit remains after the lender is paid, it is distributed to beneficiaries.
• Once the loan is fully repaid, the life insurance policy is no longer used as collateral.

How a Collateral Assignment of Life Insurance Works

Collateral assignments make sure the lender gets paid only what they are due. The borrower must be the owner of the policy, but they do not have to be the insured person. And the policy must remain current for the life of the loan, with the policy owner continuing to pay all premiums . You can use either term or whole life insurance policy as collateral, but the death benefit must meet the lender's terms.

A permanent life insurance policy with a cash value allows the lender access to the cash value to use as loan payment if the borrower defaults. Many lenders don't accept term life insurance policies as collateral because they do not accumulate cash value.

Alternately, the policy owner's access to the cash value is restricted to protect the collateral. If the loan is repaid before the borrower's death, the assignment is removed, and the lender is no longer the beneficiary of the death benefit.

Insurance companies must be notified of the collateral assignment of a policy. However, other than their obligation to meet the terms of the contract, they are not involved in the agreement.

Example of Collateral Assignment of Life Insurance

For example, say you have a business plan for a floral shop and need a $50,000 loan to get started. When you apply for the loan, the bank says you must have collateral in the form of a life insurance policy to back it up. You have a whole life insurance policy with a cash value of $65,000 and a death benefit of $300,000, which the bank accepts as collateral.

So, you then designate the bank as the policy's assignee until you repay the $50,000 loan. That way, the bank can ensure it will be repaid the funds it lent you, even if you died. In this case, because the cash value and death benefit is more than what you owe the lender, your beneficiaries would still inherit money.

Alternatives to Collateral Assignment of Life Insurance

Using a collateral assignment to secure a business loan can help you access the funds you need to start or grow your business. However, you would be at risk of losing your life insurance policy if you defaulted on the loan, meaning your beneficiaries may not receive the money you'd planned for them to inherit.

Consult with a financial advisor to discuss whether a collateral assignment or one of these alternatives may be most appropriate for your financial situation.

Life insurance loan (policy loan) : If you already have a life insurance policy with a cash value, you can likely borrow against it. Policy loans are not taxed and have less stringent requirements such as no credit or income checks. However, this option would not work if you do not already have a permanent life insurance policy because the cash value component takes time to build.

Surrendering your policy : You can also surrender your policy to access any cash value you've built up. However, your beneficiaries would no longer receive a death benefit.

Other loan types : Finally, you can apply for other loans, such as a personal loan, that do not require life insurance as collateral. You could use loans that rely on other types of collateral, such as a home equity loan that uses your home equity.

What Are the Benefits of Collateral Assignment of Life Insurance?

A collateral assignment of a life insurance policy may be required if you need a business loan. Lenders typically require life insurance as collateral for business loans because they guarantee repayment if the borrower dies. A policy with cash value can guarantee repayment if the borrower defaults.

What Kind of Life Insurance Can Be Used for Collateral?

You can typically use any type of life insurance policy as collateral for a business loan, depending on the lender's requirements. A permanent life insurance policy with a cash value allows the lender a source of funds to use if the borrower defaults. Some lenders may not accept term life insurance policies, which have no cash value. The lender will typically require the death benefit be a certain amount, depending on your loan size.

Is Collateral Assignment of Life Insurance Irrevocable?

A collateral assignment of life insurance is irrevocable. So, the policyholder may not use the cash value of a life insurance policy dedicated toward collateral for a loan until that loan has been repaid.

What is the Difference Between an Assignment and a Collateral Assignment?

With an absolute assignment , the entire ownership of the policy would be transferred to the assignee, or the lender. Then, the lender would be entitled to the full death benefit. With a collateral assignment, the lender is only entitled to the balance of the outstanding loan.

The Bottom Line

If you are applying for life insurance to secure your own business loan, remember you do not need to make the lender the beneficiary. Instead you can use a collateral assignment. Consult a financial advisor or insurance broker who can walk you through the process and explain its pros and cons as they apply to your situation.

Progressive. " Collateral Assignment of Life Insurance ."

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Kansas Legislative Research Department. " Collateral Assignment of Life Insurance Proceeds ."

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Collateral assignment of life insurance

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Using your life insurance policy as collateral is one way of securing a loan without the risk of using your home or car. Most loans are either secured or unsecured, and while an unsecured loan does not require collateral, they are not always the most affordable or available option to many loan seekers. Bankrate breaks down the collateral assignment of life insurance process along with alternative options to help you decide what type of loan may be best for you.

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Whole life insurance combines life insurance with an investment component.

• Coverage for life
• Tax-deferred savings benefit if premiums are paid
• 3 variations of permanent insurance: whole life, universal life and variable life include investment component

Term life insurance is precisely what the name implies: an insurance policy that is good for a specific term of time.

• Fixed premium over term
• No savings benefits
• Outliving policy or policy cancellation results in no money back

This advertising widget is powered by HomeInsurance.com, a licensed insurance producer (NPN: 8781838) and a corporate affiliate of Bankrate. HomeInsurance.com LLC services are only available in states where it is licensed and insurance coverage through HomeInsurance.com may not be available in all states. All insurance products are governed by the terms in the applicable insurance policy, and all related decisions (such as approval for coverage, premiums, commissions and fees) and policy obligations are the sole responsibility of the underwriting insurer. The information on this site does not modify any insurance policy terms in any way.

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.

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 you might 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?

Both main types of life insurance, term life insurance and permanent life insurance , can be used to secure a loan. If you have a policy that falls into a subcategory of permanent life insurance, such as whole life, universal life, variable life or variable-universal life, these too are eligible to be used as collateral. 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.

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.

Unsecured loan

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 permanent 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

What is the best life insurance company, what type of loans are collateral assignments usually associated with, what are other common forms of collateral, related articles.

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What Is a Collateral Assignment of Life Insurance?

Shawn Plummer

CEO, The Annuity Expert

A life insurance policy is assigned as collateral for a loan, and the primary beneficiary of a death benefit is designated as the lender. If the borrower fails to repay his or her debt, the lender may redeem the life insurance policy and recoup what wasn’t paid.

Businesses are willing to accept life insurance as collateral since it provides a guarantee of money if the borrower dies or defaults. The lender receives the amount owed through the death benefit, and any outstanding balance is then transferred to other specified beneficiaries, in the case of the borrower’s death before repayment.

The policy must be owned by the borrower and not necessarily the insured, and the terms of the loan must remain in force throughout the life of the loan. A collateral assignment may be used with any sort of life insurance policy if it is approved by the insurance company.

Permanent life insurance with a cash value allows the lender access to the cash value, which may be used as loan payment if the borrower defaults. Because term life policies do not accumulate money value and have a policy duration that is insufficient to accommodate the loan, many lenders refuse to accept them as security.

The owner of the insurance policy’s access to the cash value may be restricted in order to safeguard the collateral. If the loan is paid off before the borrower dies, the assignment is annulled, and the lender no longer receives a death benefit as a beneficiary. Prior notification of a policy’s collateral assignment is required by insurers.

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Why use life insurance as collateral?

There are several good reasons to use life insurance as collateral for a loan. Here are a few examples:

• It might be cheap. Life insurance costs vary depending on various factors, including your age, health, policy type, and the coverage amount. However, life insurance premiums may be lower than you would pay for an unsecured loan with higher interest rates.
• Your belongings are more secure. You may be able to obtain a secured loan without putting your house or automobile at risk if you use life insurance as collateral. If you die before the debt is paid off, the lender will utilize your life insurance payout to do so.
• Lenders may be more inclined to provide financing if you have life insurance. Many lenders consider life insurance to be a sensible option for collateral since they are confident that they will be able to repay your loan should you die.

There are some situations when the collateral assignment of life insurance is not the best option. For example, some people can’t get affordable life insurance because they’re old or sick. It might also be challenging to use an existing life insurance policy as collateral for a loan; a lender may want you to take out new life insurance just for this reason.

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Guidelines for Collateral Assignment of Life Insurance

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Lions Financial provides comprehensive guidelines for the collateral assignment of life insurance. The collateral assignment involves using a life insurance policy as collateral for a loan or debt. Lions Financial assists individuals and businesses in understanding the process and implications of collateral assignment, ensuring they make informed decisions.

The guidelines cover important aspects such as determining the policy’s cash surrender value, establishing the assignment amount, and defining the rights and responsibilities of the assignee and assignor. Lions Financial also helps clients navigate legal and tax considerations related to collateral assignment.

Banks require insurance for collateral assignment so that they can always get any outstanding loan amount back if the loaner defaults or dies before being able to pay the loan back.

Collateral is pledged as security for repayment of a loan, to be forfeited in the event of a default. A collateral assignment of insurance is a conditional assignment appointing a lender as the primary beneficiary of a benefit to use as collateral for a loan. If the borrower is unable to pay, the lender can cash in the insurance policy and recover what is owed.

An Absolute assignment in insurance involves signing over your entire policy to another person or entity. The person who is selling or gifting the policy is known as the assignor, and the individual or individuals who receive it are the assignee. The assignee takes full ownership of the policy, being held liable for any premiums and also having the authority to change or designate new beneficiaries.

Collateral assignment of life insurance essentially works like a standard loan. The insurance policy is “collateral” for a loan, and the person or organization that pays out that loan is the temporary beneficiary of the policy’s death benefit until the loan is repaid. The entity taking over the policy does so on a conditional basis and, therefore, doesn’t have the authority to make changes to it, re-sell it or take any of its cash value. Instead, the assignee can only draw on the death benefit if the policyholder defaults.

On the other hand, Collateral Assignment enables policy holders to regain control of their own policy once a medical or other crisis has resolved. It is one of the 3 common ways to borrow from your life insurance policy and access the cash value. With a collateral assignment, you are able to eventually benefit again from the long-term advantages of a life insurance policy.

If one already has a life insurance policy with a face value greater than the loan amount, he can collaterally assign that policy by requesting the paperwork from the insurer. If one doesn’t have a life insurance policy or needs additional coverage, he will need to apply for life insurance and go through underwriting.

Whether one has a term life insurance policy or a whole life insurance policy, he will be the policy owner and responsible for the premium payments. The borrower must be the owner of the policy but not necessarily the insured, and the policy must remain current for the life of the loan with the owner continuing to pay all necessary premiums.

Any type of life insurance policy is acceptable for collateral assignment, provided the insurance company allows assignment for the policy. Some banks may require an escrow account for the life insurance premiums, others may require proof of premiums paid or prepaid.

If one has a whole life policy that he uses for collateral assignment, banks will have access to the cash value of the policy if he defaulted on the loan. If the loaner dies, the insurance company will use the death benefit to pay off any outstanding loan amount. The rest, if any, goes to the assigned beneficiaries.

Insurance companies must be notified of the collateral assignment of a policy. When one is applying for life insurance for the purpose of collateral assignment, he will name his beneficiaries as he would for a personal policy. The bank is not his beneficiary, but the assignee on the collateral assignment after the policy is in force. On the form, he will be the assignor.

There are several reasons to consider a collateral assignment of life insurance. The Collateral assignment guarantees the safety of the amount that was loaned out to the lender, especially under the listed terms and conditions that the lender will be paid in full; moreover, the remaining will be given to the listed beneficiaries in the case of death of the borrower.

• It safeguards the interests of the lender. A collateral assignment plays a critical role in securing a loan for the borrower. It is the insurance company’s obligation to safeguard the lender’s interest after collecting the collateral assignment form.
• A collateral assignment allows you to be more flexible with your capital assets.
• A collateral assignment allows the borrower to purchase insurance as a low-cost collateral to secure paying back a loan.

A collateral assignment has great advantages, but it has certain limitations as well. First of all, a collateral assignment has a limited death benefit. You should assign part of the death benefits as collateral instead of the total benefits which avoids the circumstances where the lender claims all the death benefits after you die.

• Difficulty in obtaining an affordable insurance policy with low premiums.
• Loss of policy control is another disadvantage of collateral assignment.
• Collateral assignment suffers from the limited use of cash value.

Any type of life insurance policy is acceptable for collateral assignment, provided the insurance company allows assignment for the policy.

Some examples of insurance policies you can use for collateral assignment are:

• Term Insurance

Term life insurance is used to offer coverage for a specific number of years. The proceeds of the policy are only paid out after the insurer dies, and it lacks equity and a surrender value. It falls under the category of the most affordable insurance plans which is why it is a top pick for most people.

You don’t need to buy a plan that exceeds or falls below your needs. Term life insurance enables you to purchase a plan tailored to your needs and since it is not permanent, you are going to pay low premiums.

• Universal Life Insurance or Whole Life Insurance

With universal life insurance, you will be able to design the insurance policy according to how you want it. The insurance proceeds are usually released when the insured party dies. It is great for individuals looking for a permanent insurance policy that never expires unless you are dead. In short, you will continue to receive coverage as long as the annual premiums are getting paid.

On the downside, universal life insurance policies tend to be expensive because they are meant to offer life term coverage.

On the bright side, the policies build cash value and the longer the premiums are paid,  the more value the plan will build. This cash value can be used on other investments or to pay off the outstanding premiums.

When applying for a collateral assignment of life insurance, you can use two ways to do so: through the bank or through your insurer. The two are explained further below;

• APPLYING THROUGH YOUR BANK

There are some lenders who will consider using your existing life insurance policy for collateral assignment if you request it, but others might require you to take out a brand-new policy specifically  for that purpose.

In either case, using life insurance for collateral assignment when applying for loans is a fairly common practice that almost every life insurance company and the bank is equipped to handle.

You start off the application for assignment by securing the loan with the bank in question. This is where you will discover the limitations and regulations the bank has regarding the collateral assignment of life insurance. Each lender has different policies.

• APPLYING THROUGH YOUR INSURER

Once you have found the right loan, you must fill out the collateral assignment form. Your insurer will be able to provide you with this form easily.

The form has to be filled out by every party involved, including yourself, the lender, and the insurance company. You can sign the forms at the time of your loan application or you can sign them after your policy has been issued.

If you are taking out a brand-new life insurance policy, you are better off signing all of the documents for this at the beginning of the application. The time frame to request a collateral assignment and be accepted for it ranges between 24 hours and 48 hours.

Some banks might require that you notarize the form, which can add some time to the application and acceptance process

  There are several essential parts to be included in the collateral assignment forms.

1.  Policy Identification

This part focuses on the information of the insured, including policy numbers, owner’s first and last names, address, phone number, and email address.

2. Assignee information:

This part contains information about the assignee. The assignee could be an individual, corporate entity or trust. If the assignee is a Trust, he/she ought to list out all the names of currently serving trustees.

Moreover, this part should include the assignee’s full legal name, address, tax ID, email address, and phone number. 3. Terms and conditions: This section lists all the terms and conditions of the assignment. To be specific, this section covers in detail the rights, for instance, “the sole right to collect from the Insurer the net proceeds of the policy, the sole right to obtain one or more loans or advances on the Policy”, etc. Moreover, this section might also include IRS certification to certify the taxpayer identification number filed in the previous sections are authentic and correct.

4. Signatures: All owners and assignees are required to sign and date in this section after reviewing the previous terms and conditions. Moreover, beneficiaries are also required to sign this form. 5. Submission of the assignment form: After careful revision of terms and conditions of the assignment and signature, the assignment form should be submitted for processing. This part should list detailed instructions for sending back the assignment form. Moreover, this part should also provide the address, contact information, and the fax number of the company who issued the policy.

You apply for a life insurance policy and name your beneficiary (your spouse, children, whomever). Just as you normally would. After the policy goes into force, a collateral assignment form from the life insurance company will be sent for you to complete. When a life insurance company sets a collateral assignment of life insurance, this usually takes in the region of seven to ten days to be filed and acknowledged. However we may expedite this if the collateral assignment is required more urgently.  When taking out life insurance at the same time as assigning the collateral, the collateral assignment form must be submitted with the life insurance application. You get the collateral assignment form signed (some companies require a notarized signature). It will take a few days to a few weeks for the life insurance company to acknowledge the assignment. Once the loan has been paid in full, the assignment must be lifted from the policy by means of a release form sent by the lender to the insurance company. When it receives the release, the insurance company cancels the assignment and restores all rights in the policy to the owner. A collateral assignment allows the life insurance company to pay your SBA lender only what they are owed and the rest goes to your beneficiary. As you pay down the loan, the amount of coverage will be more than you need, and a collateral assignment form makes sure the lender is only paid what is needed. If you named the lender as the beneficiary, the lender would receive the entire death benefit even though you’ve paid down the balance. And if you did that, the life insurance company wouldn’t issue you the amount of coverage needed – they’ll typically only issue 80% of the loan amount. So, it’s imperative that you use a collateral assignment. The Collateral Assignment of Life Insurance is a way to secure funding for business or other ventures. It is important to understand the different types of assignments and how they work before choosing this option.  At Lions Financial, we offer a variety of services and resources to help businesses secure funding and protect their assets. 

To learn more about these services, sign up for our newsletters or make an appointment with a representative today!   Contact us at https://lions.financial/contact/   Learn more, visit:   What Are the Tax Considerations For Life Insurance Premiums Under Collateral Assignment For Business Bank Loans     Should You Consider An Asset-Based Loan For Your Business   Process For A Business To File a Life Insurance Claim   Life Insurance Requirements for SBA Loans    Life Insurance Requirements when getting an SBA Loan The sources we use for this information include: https://www.investopedia.com/terms/c/collateral.asp   https://www.investopedia.com/terms/l/lender.asp   https://www.investopedia.com/terms/b/beneficiary.asp  

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How to use Life Insurance as Loan Collateral?

Using a life insurance policy with cash value as collateral can help you get a loan without using other assets. But borrowing against it can reduce the death benefit for your beneficiaries if you can't make payments.

Steve is a seasoned insurance advisor and expert in difficult-to-insure cases. He's helped 1000s of clients get the right life insurance.

You'll learn:

If you need access to money quickly, using your life insurance policy as collateral assignment could help you acquire the funds you require.

While there are numerous lending options, they typically fall into two categories: unsecured and secured loans. Secured loans are easier to obtain and have lower interest rates, but collateral is required.

You might offer an asset as collateral assignment, such as your home or car, but you will be taking a significant risk. If you default, you may lose your home or automobile.

Using life insurance as loan collateral assignment instead of your home or another asset may be a suitable option. Continue reading to learn more.

Can you use life insurance as collateral assignment for a loan?

Life insurance pays out a death benefit to your loved ones when you pass away. However, it can also be used for other purposes.

Permanent life insurance plans, such as whole life insurance, accumulate cash surrender value that can be used as collateral assignment for a loan. Lenders may allow you to borrow 80% to 100% loan-to-value if you offer your policy as collateral assignment.

The cash surrender value component transforms your policy into a tangible asset, similar to a car or your home. If you default, the lender can recover the loan amount from the cash value of your policy.

How to borrow from a life insurance policy?

Whole life and universal life insurance are two forms of cash value permanent life insurance products. When you pay your life insurance premium, the insurer uses it for three purposes: • To pay the cost of life insurance • To cover various administrative fees • To increase cash value

The cash value of whole life insurance policy grows at a fixed rate determined by the insurer. With universal life insurance, you have control over how the cash value grows. The insurer allows you to select sub-investment accounts related to the cash value from a pool of limited possibilities. You may earn a higher rate of return with the right investments. But, if the sub-accounts you choose do not perform well, you may quickly lose the majority of your accumulated wealth.

Find the best rates

The cash value increases on a tax-deferred basis, which means you pay tax only when you withdraw it. This arrangement allows you to possibly save more money while paying less tax on investment gains.

Since it is your money, you (the policy owner) can access the policy's cash at any time. When you pass away, your beneficiaries only receive the death benefit, not the cash value.

The accumulated cash value can be accessed in the following ways:

Use it to secure a loan

You can borrow money using your life insurance policy as collateral assignment. If you default, the lender can claim your cash value as an asset. The amount of money you can borrow by pledging the policy as security varies per lender. Nonetheless, you may be able to borrow up to 100% loan-to-value in some cases.

Using life insurance policy as loan collateral assignment can provide you with much-needed funds, but the practice is not without risks. For example:

If you can't repay a loan, the lender subtracts the balance from your policy's cash value, reducing the death benefit. Each withdrawal directly decreases the benefit. For example, with a policy of $1 million face value and $100,000 cash value, if you default on a $50,000 loan, the lender reduces the cash value accordingly, so your dependents would receive $950,000, not the original $1 million.

Generally, you can borrow against your insurance after it has been in place for a specified amount of time.

Take out a policy loan

A policy loan allows you to borrow money from the insurer while using the cash value of the policy as security. You can borrow no more than the current cash value of your policy. These loans are offered on permanent life insurance policies, such as whole life or universal life policies , that have enough cash worth to borrow against.

The insurer will charge you interest on the loaned amount, which may be more than the interest rate charged by standard secured loans. But, they differ from other types of loans in one important way: you are not compelled to repay the borrowed money.

A policy loan is simply an advance payment on the money you would receive if you surrender the policy. You can choose not to give back the money because it is money you would have received anyway. Nonetheless, the insurer will deduct the principal amount plus interest from the death benefit in that scenario.

In other words, if you do not repay, your beneficiaries will. The insurance will recoup the money it loaned you in some way.

Although they have higher interest rates than bank loans, they can still be a reasonable option in the following circumstances:

• You have a bad credit history A bank performs a credit check before lending, making poor credit history a hurdle for approval. However, for a policy loan, there's no credit check due to its private nature and the insurer holding your money, thus, past credit isn't a concern.

• Quick approval Getting a policy loan is really simple. Simply complete a one-page loan application to obtain the funds you require.

• Minimal financial requirements Borrowing up to 90% of your cash worth is common, with sums as low as $1,000 being possible.

• Financial discretion A policy loan does not appear on your credit report, or anyplace else.

Withdraw your cash value

You can withdraw money from your cash value account at any moment, but you will be charged a fee each time. Keep in mind that when you withdraw money from the cash value, the death benefit is reduced dollar for dollar. If you withdraw $50,000, your beneficiaries will receive $50,000 less after you die.

You can also withdraw the entire cash amount by surrendering the policy. In the insurance industry, "surrendering a policy" is synonymous with "cancelling it." When you surrender a permanent life insurance policy, you receive the net cash value (actual cash value minus surrender charges) and the policy expires. If you pass away, your beneficiaries will receive no monetary compensation.

How much money can you borrow against a life insurance policy?

In general, you can borrow up to 90% of the cash value of your insurance by using it as collateral assignment. When selecting how much money to borrow, a third-party lender would analyze your specific situation, such as your creditworthiness and the cash value growth rate.

What Are the Benefits of a Life Insurance Collateral Assignment?

A collateral assignment form of life insurance can assist you in getting a loan. Lenders frequently make it a prerequisite for a business loan. The bank knows that if you pledge your policy to get a loan, it will not lose money if you default or pass away before repaying it.

How does using my cash value as collateral work?

When using cash as collateral assignment for a loan, you must name the lender as an assignee. If you are unable to repay the loan, the lender can cash in the policy to reclaim the lent money or wait until you pass away to get a portion or all of the death benefit as payback of the debt.

Why use life insurance as loan collateral?

Assigning life insurance as collateral assignment allows you to secure a loan without committing property or assets to the lender. If you fall behind on your payments, you may lose your life insurance coverage, which, while undesirable, may not be as severe as losing your home. You can also purchase another life insurance policy to ensure that your family receives a payout to help them survive after you die.

Will the proceeds of a life insurance policy loan be taxed?

You can get money tax-free if you borrow from a third party lender and use life insurance as collateral assignment. But, if you get a life insurance loan from your insurer, you must pay tax on the portion of the borrowed amount that exceeds your policy's adjusted cost basis (ACB). The same is true of policy withdrawals.

A life insurance policy's ACB is the sum of premiums paid less the net cost of pure insurance. For example, say you have a perpetual life insurance policy and pay $4,000 in premiums each year. The net cost of pure insurance is $1,000, with $2,500 used to grow cash value and the remaining $5,000 used to keep the policy in force. In this situation, the ACB of your coverage is $3,000.

Example of Collateral Assignment of Life Insurance

Here's an illustration. Steve wants to create a web hosting company and requires a loan of $65,000 to do it. His bank agrees to lend him this sum in exchange for the assignment of his life insurance policy as collateral assignment. On his life insurance, which has a face value of $400,000 and a cash value of $80,000, Steve names the bank as an assignee.

This way, the lender is guaranteed that the money will be returned even if Steve defaults on the loan or dies before repaying it. Since the death benefit and cash value are greater than the loan amount, Steve's beneficiaries will get a payout after he passes away.

Alternatives to Collateral Assignment of Life Insurance

By assigning your life insurance as collateral assignment, you can secure a business loan (or a personal loan). If you are unable to make the loan payments, you risk losing coverage. If this occurs, your beneficiary will not receive the compensation you intended for them.

Other popular ways for getting a loan without the use of life insurance as collateral assignment include:

A Policy loan

The insurer will let you borrow against the cash value of your coverage. Policy loans are not subject to an income or credit check, and they are not taxed. But, this option is only available if you have a whole life or universal life insurance. Because term life insurance policies do not accumulate cash value, it cannot be used to get a life insurance loan.

Surrendering your life insurance policy

If you have a large cash value in your insurance, you can obtain it by surrendering the coverage. Nevertheless, once you do so, your coverage will terminate, and your beneficiaries will not get any death benefits if you die.

Home equity loan

A home equity loan is a sort of loan in which you borrow money against your house's equity. The difference between the current market value of your home and the outstanding mortgage is your home equity. If your home is currently worth $300,000 but you still owe $150,000 to your mortgage lender, you have $150,000 in equity.

Normally, you can borrow up to 85% of the value of your property. A home equity loan is a second mortgage that pays off the first mortgage's balance and then provides you the remaining funds.

Continuing with the above example:

1. You might borrow up to $240,000 (85% of the current value of your home, which is $300,000). 2. Because you still owe $150,000 on your first mortgage, you might finance up to $90,000 (keep in mind that home equity loan closing expenses normally vary between 2% and 5% of the loan amount).

Home Equity Line of Credit (HELOC)

Another way to access your home equity is through a HELOC. A HELOC is a secured line of credit that allows you to borrow money using your home equity as security on an as-needed basis.

HELOCs often offer lower interest rates than home equity loans, which means you may pay less interest over the life of the loan. These may be more difficult to manage, though, because neither the interest rate nor the monthly installment is fixed. A home equity loan, on the other hand, has a fixed interest rate and fixed monthly payments.

What Types of Life Insurance Can be used as Collateral?

There are two types of life insurance: term life and permanent life. Term life insurance covers you for a set amount of time and does not accumulate cash value. Permanent life insurance remains in place as long as you pay the premiums. Most permanent life policies (but not all) have a cash-value component.

Pick the right policy beneficiary

A common — and potentially costly — mistake is to name the lender as a beneficiary of their policy rather than an assignee. If you identify the lender as an assignee, the lender will receive the amount owed from the insurance proceeds, with the remainder going to your beneficiaries. If, on the other hand, the lender is the beneficiary, it will receive the entire death benefit, which could be substantially greater than the loan sum. Also, your heirs will not be compensated in this circumstance.

Is a life insurance policy loan risky?

You can get funds for your business or personal requirements by using life insurance as loan collateral assignment. But, there are some drawbacks to the relocation that you should be aware of.

The possibility of outliving your expected demise

Lenders base the loan amount not on your current cash, but on your estimated cash value at death, often allowing you to borrow up to 90% of it. However, if you live longer than anticipated, the lender might require early repayment or additional collateral assignment.

Interest rate and return rate assumptions

The lender sets your interest rate considering the cash value growth rate. However, if the interest rate increases or your cash value underperforms, they may request early repayment or additional collateral assignment.

Still, despite risks, loans financed by life insurance are popular and often favored over traditional secured loans, which utilize personal assets as security.

Using Permanent Life Insurance as Collateral

If you have a permanent life insurance policy, you can use its cash value as collateral assignment to secure a loan. Borrowing against your policy, however, is not without risks. If you cannot make your loan payments, your loved ones may receive a reduced death benefit or no money at all when you die.

At Dundas Life, we recognize that making financial decisions can be difficult. That is why our team of specialists is here to assist you in using your permanent life insurance policy as collateral assignment.

Reach out to us today to find out how we can assist you in weighing the risks and benefits and making an informed decision about your financial future.

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Collateral Assignment

What is a collateral assignment.

With regards to life insurance , a collateral assignment is a loan agreement between a borrower and a lender in which the borrower uses a life insurance policy they own as collateral for the loan.

How collateral assignment works

When you need a loan, you can choose between unsecured and secured financing. Secured loans come with lower rates, but they require you to present collateral. The lender can collect that collateral if you default on the loan.

A collateral assignment allows you to put a life insurance policy that you own up as collateral for a loan. Many lenders like this option because it essentially guarantees that if you’re unable to pay back what you owe due to premature death, they can collect it from the life insurance company .

When you have fully repaid the loan, the collateral assignment terminates. At that point, the beneficiaries named in your policy will get the full death benefit distributed to them.

The benefits of collateral assignment

A collateral assignment gives you a way to make sure that the lender only gets repaid for what you still owe. With this agreement in place, they will receive whatever portion of your death benefit is necessary to cover the outstanding loan amount. But any leftover monies will get distributed to your beneficiaries.

If you simply name the lender as a beneficiary rather than establishing a collateral assignment, the lender gets the death benefit in full, regardless of how much of the loan you’ve already paid off. In other words, the collateral assignment allows you to repay your debts while leaving as much money as possible for your beneficiaries.

Collateral assignment with types of life insurance

Not all life insurance policies are eligible for collateral assignment. Many lenders only accept permanent life insurance policies because these policies will stay in force for the insured’s lifetime (provided the policy owner continues making premium payments). With term insurance , on the other hand, there’s no guarantee that the policy owner will want or be able to cover the inflated premiums that arise at the end of the policy term.

That said, if the loan you want comes with a term that’s shorter than the term on the life insurance policy you want to use as collateral, the lender may consider it.

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Collateral Assignment of Life Insurance Policy | Practical Law

Collateral Assignment of Life Insurance Policy

Practical law canada standard document w-020-7658  (approx. 14 pages).