Can you use your life insurance policy as collateral?

Most life insurance policies can be used as collateral for obtaining loans. It is a good idea to double check with your insurance company to make sure they allow this practice.

If it is allowed, the process is called a collateral assignment of life insurance. If the borrower dies before the loan is paid off, the lender can claim the remaining balance from the life insurance proceeds.

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Does the lender have a claim over the stated beneficiary?

The lender has priority over the other named beneficiary of the policy. Once the loan has been paid, the remaining balance of the death benefit is paid to the remaining beneficiaries.

–Special Stipulations

• The borrower, using the policy as collateral, must be the policy owner. They do not necessarily have to be the insured; however, they usually are.
• The owner must make sure the premiums are paid and coverage is in force for the duration of the loan.
• Most types of insurance policies are allowed including term and whole life insurance.
• The insurance company must be notified of the assignment, because it is a change in beneficiary. The lender becomes a beneficiary on the policy.
• The lender must be notified that the life insurance collateralization process has begun.
• Most lenders require the premiums be paid-up at least 6 months.

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Who controls the cash value on a collateralized policy?

Access to the cash value of a life insurance policy is transferred to the lender when it is used as collateral.

Otherwise, the owner could borrow against the cash values, lowering the death benefit. By having access to the cash value, the lender can use this if loan payments are missed.

They can use it to pay for missed premiums on the collateral as well.

Why Lenders May Require Borrowers to Have Life Insurance Collateral

Many lenders require that borrowers use life insurance as collateral because they are concerned that when making a loan to a small business, the key person’s death could lead to a collapse of the business.

If a business owner does most of the work keeping a company up and running, if they die before the loan is fully paid, the lender is guaranteed to recover their money.

Basic Provisions in a Collateralized Loan

Lenders will require specific items be included in the collateralization document. Some of the main things include:

• The assignment must be filed at the insurance office before the lender will accept it as valid.
• The insurance company is not responsible for the effect, sufficiency or validity of the assignment.
• If there are loans against the cash value already, they take precedence.
• The assignee will receive notices of lapse.
• The owner cannot take a loan against the policy unless the lender approves.

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Things the Lender Will Demand

The lender will usually require that the insurance company send them an official letter stating the there is no other claim against the insurance policy. If there is, they will want the details.

They will also want verification that premiums have been paid up for 6 months. They will also want to know if the owner has borrowed against the cash value.

The lender will demand that the life insurance plan be paid to keep it in force.

If the owner allows the policy to lapse before the loan is paid off, it may be considered the same as defaulting on the loan. If this is the case, the lender can make the total amount of the loan due immediately.

These details will be spelled out in the loan documents.

Other Ways to Use a Life Insurance Policy as Collateral

Many policy holders borrow from the insurance company, using their life insurance policy as collateral. This is done through borrowing from the cash value.

This can obviously be done only on a whole life policy or a universal life policy with cash values.

A benefit to borrowing in this manner is that you don’t have to go through an approval process. Another advantage is there is not set repayment schedule.

One of the disadvantages is the company will charge about an 8 percent interest on the borrowed funds. Even if you don’t pay the interest, it will go against the value of your policy.

If you can get a lower interest rate from a bank or other institution, you can allow your cash values to continue growing at higher rates, and pay the lower interest from the bank.

Other Things You Should Know About Using Life Insurance as Collateral

Some life insurance companies require that the original life insurance policy be presented to file a claim, so most lenders will require you to leave the original with them.

Only some insurance companies allow for more than one lender to be attached to the policy at one time. Some do not.

When the loan is paid in full, the lender’s interest in the policy is terminated and the original policy is returned to the owner.

If the insured dies, the lender will have first claim to proceeds. After they are paid the remaining beneficiaries receive the balance.

For the most part, it is fairly easy to use a life insurance policy as collateral for a loan.

If it has cash value, the lender typically has access to it as well as a priority claim against death benefit proceeds. Some insurance companies allow for multiple assignee’s, meaning that there can be more than one lender.

Check with the insurance company to make sure they allow assigning. Most do, but there are a few who don’t. You can assign an existing life insurance policy as collateral or you can apply for a completely separate policy to serve a collateral.

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