Collateral Assignment

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    Collateral Assignment: How To Use Life Insurance To Get A Loan

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    Applying for a loan can be one of the most stressful experiences of your life. Not only do you have to submit your personal information and bank records for review, but you also have to prove to the lender that you can repay the money you owe them.

    One of the best ways you can do this is by putting down a life policy as collateral for a loan. This practice is called the collateral assignment of life insurance. This allows the lender to use your insurance policy's death benefit in case you default on your loan.

    In this guide, we'll talk about how to use your life insurance policy as collateral. We'll also answer all the most frequently asked questions on the topic.

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    What Is Collateral Assignment Of Life Insurance?

    Collateral refers to anything (like property or assets) that a borrower presents to a lending institution as a guarantee of loan repayment. If you decide to use a life insurance policy as collateral, you will enter an agreement called the collateral assignment of life insurance. 

    Doing this assures the lender (like a bank or a credit union) that they'll be able to recover the money you owe them in case you pass away or default. Instead of paying out to your beneficiaries, the death benefit is used to pay off your personal or business loan.

    Collateral is generally required for business owners who want to take out SBA loans, structured settlement buyouts, and bank loans. In fact, many lenders don't issue a loan unless you have a life insurance policy with a collateral assignment. On top of this, strict lenders may also require you to provide proof of prepayment or prepayment on your insurance premiums.

    With collateral assignment of life insurance, the borrower is listed as the policy owner and is responsible for paying premiums. Regardless of the type of policy you use for the collateral assignment, it should remain in effect throughout the life of the loan. In other words, you cannot have a policy that expires before your loan matures.

    Collateral Assignment Of Life Insurance vs Credit Life Insurance

    It's important not to confuse a collateral assignment with credit life insurance. While they serve a similar purpose, which is to assure the lender of your creditworthiness, they differ as to who they consider as your beneficiary.

    For credit life insurance, the lender (not you, the borrower) is the sole beneficiary of your policy. The sum assured is equal to the amount of your loan, and it decreases proportionately with the outstanding loan amount. Since this type of life insurance is designed to pay off your loan, your family will not receive any money from the death benefit.

    For a collateral assignment, the bank will be first-in-line to receive your death benefit. Of course, they'll only have the right to claim the amount due to them. 

    Let's say that the coverage amount on your life insurance policy is $100,000, and you owe the bank $45,000. The lender will only receive $45,000 from the insurance company. The rest of the money will go to your other listed beneficiaries, like your family.

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    Types Of Insurance For Collateral Assignment

    Most types of life insurance can be used as a collateral assignment, as long as the insurance company allows it. The lender must also agree to use the life insurance policy as collateral.

    Here are some types of policies you can use as collateral:

    No-Exam Life Insurance

    No-exam life insurance is often the most ideal type of insurance for collateral assignment. The application process is quick, allowing you to fulfill your loan requirements sooner rather than later. Some insurance companies may issue a no-exam policy within a couple of days.

    No-exam life insurance usually has more expensive premiums compared to typical life insurance. The higher premiums are designed to offset the risk of providing you with coverage without a medical or health check.

    Term Life Policy

    Term life insurance is a fairly common option for collateral assignments. It provides you with insurance coverage within a specific term, usually from 1 to 30 years. As the policy owner of a term policy, you can expect to pay cheaper premiums while still getting the coverage you need.

    If you use term life insurance for collateral assignments, the face amount (or the death benefit) must be larger than your outstanding loan balance. Plus, the life insurance's term period must be past your loan's maturity date.

    Keep in mind that there are lenders that won't allow you to use a term life insurance policy as collateral. That's because this type of life insurance doesn't accumulate a cash value. Additionally, some term policies don’t offer high enough coverage to shoulder the loan in case you default.

    Whole Life Insurance Policy

    Whole life insurance is the most basic form of permanent life insurance. It provides you with insurance coverage your entire life, as long as you keep on paying premiums.

    One key aspect of a whole life policy is that it has a cash value component. In some cases, the borrower needs to provide the lender access to the cash value. This helps pay off your loan in case you default and need the insurance company to cover your balance.

    Universal Life Insurance

    Universal life insurance is another form of permanent life insurance. Premium payment amounts can be flexible, depending on your current insurance needs. It also has a cash value component, which the lender can draw from in case you default on your loan.

    Guaranteed Universal Life Insurance

    Guaranteed universal life insurance is another form of permanent life insurance, except that it doesn't usually come with a cash value component. Additionally, the death benefit and premium payments are not flexible.

    One reason to get guaranteed universal life insurance is that it offers you a way to get lifetime coverage at a cheaper rate compared to a whole life policy.

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    Collateral Assignment Process: A Step-By-Step Guide

    Collateral assignment of life insurance more or less follows the same application process as regular life insurance. There are a few extra steps, however – here's a detailed guide for your reference.

    1. Pick An Insurance Company

    The first step is choosing an insurer. You can select an insurance company on your own or ask a life insurance agent to help you pick the best one for your situation. Make sure you request quotes for multiple life insurance policies to see which one fits your needs and budget.

    2. Apply For A Life Policy That Qualifies For Collateral Assignment

    Most life insurance companies will allow you to start the application process online through their websites. Usually, you’ll need to divulge your personal information, social security number, and health status or medical history.

    Before you complete the life insurance policy application process, confirm with your insurance company and lender that you can use the life insurance as collateral for a loan.

    3. Decide On The Face Amount

    Face amount refers to the death benefit your beneficiaries will receive if you pass away. In the case of a collateral assignment, you have to make sure that the death benefit exceeds the amount that you're borrowing. For example, if you're taking out a loan for $80,000, then your face amount needs to be $85,000 or more.

    4. Name Your Beneficiary

    Even if you want to use life insurance for a collateral assignment, you should still name your family or close relatives as your primary and contingent beneficiaries, as you would with typical life insurance.

    You’ll later name the lender as the assignee on the collateral assignment form. That will give the lender the right to claim a part of your death benefit to recover your outstanding dues.

    5. Pass The Underwriting Process

    Just like with regular life insurance, you'll have to undergo the underwriting process. If you need a policy urgently, you can opt for a no-exam policy, which does not include a medical exam and can be issued to you within a few days.

    6. Get The Policy Active

    Once you're approved for a life insurance policy, you'll need to pay your first insurance premium. After the life insurance company receives your payment, they will confirm that the policy is active. If you're not using the policy as collateral for a loan, this is usually the final step.

    5. Fill Out The Collateral Assignment Form 

    This is where the formal collateral assignment process begins. First, tell your insurance company or broker that you'll need a collateral assignment form, then fill it out with your personal information. You'll usually need the loan officer's name and number, as well as your policy number and social security number.

    6. Pay Off Your Debt

    Pay off the money you owe to the lender within the schedule defined on your loan contract. Depending on your loan terms, this can take 1 to 25 years or more.

    7. Obtain A Collateral Assignment Release Form

    Once you've paid off your debt, you need to contact your life insurance agent or company to tell them that you no longer need to use a collateral assignment. They'll require a release form from your bank, which signifies that they no longer have a right to claim the death benefits.

    8. Submit The Release Of Assignment Form To The Life Insurance Company

    Once the bank issues a collateral assignment of life insurance release form, their relationship with the life insurance company (and the borrower) ends. You can continue to keep the policy for personal reasons or allow it to terminate.

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    Frequently Asked Questions On Collateral Assignment Of Life Insurance

    Using life insurance policies as collateral can be complicated, especially if you're a first-time borrower. In this section, we've answered some of the most common questions about this practice.

    Do you need a new policy for a collateral assignment?

    In general, you can take an existing life insurance policy for a collateral assignment. However, keep in mind that not all life insurance policies can qualify for this purpose.

    For example, if you have a term life insurance policy that will end before your loan gets paid off, then you can't use it as collateral for your personal or business loan. Additionally, if your existing life insurance policy's death benefit is less than your desired loan amount, then you can't use it for a collateral assignment, either.

    In case your existing insurance policy doesn't qualify, you'll be required to buy a new policy.

    Can I have multiple collateral assignments for one life insurance policy?

    Yes. You can assign multiple lenders for collateral assignment of life insurance.

    The requirements for doing this is the same as assigning one lender to a life insurance policy. As long as your policy has a face value large enough and a term length long enough to cover multiple loans, then you may try to use it as collateral for two or more loans.

    As usual, the lending institution and the insurance company must both agree to this arrangement.

    Can I change my collateral assignment to a different life insurance policy?

    Yes, but you'll have to make sure that both the insurance company and the bank will agree to the change.

    When will the collateral assignment terminate?

    The collateral assignment will be terminated once the loan has been fully repaid. You have to ask the lender to send a release form to your insurer. This form declares that you've paid your dues and the lender is ready to terminate the collateral assignment.

    What happens if the policy lapses due to non-payment?

    If you cancel your life insurance coverage or allow it to lapse, the lender may consider that as a violation of your loan contract. Inform your lender immediately if you're unable to pay the premiums on your policy to discuss your options. In this case, the lender can withdraw money from your policy's cash value to cover your existing debt.

    If your policy doesn't have a cash value, the lender will be forced to deduct more money from your policy's death benefit to cover the premiums they paid on your behalf. For instance, let’s say the bank was originally given the right to claim $50,000 under your collateral assignment contract. They can claim $55,000 if they had to make additional premium payments to prevent your life policy from lapsing.

    If I'm using life insurance as collateral, can I still take out a policy loan?

    In most cases, yes. However, you'll need prior written consent of the bank or lending institution before you can make a life insurance policy loan.

    What if I accumulate enough cash value to cover my loan?

    Some types of permanent life policies can accumulate a cash value large enough to cover your current loan. In this case, the lender will get the cash value after your death. Your beneficiaries (like your family) will receive the entire death benefit.

    Who do I assign as my beneficiary?

    Life insurance companies will require you to list a primary beneficiary. This beneficiary can be your spouse, children, or other next-of-kin. Your beneficiaries can use the funds from the life insurance policy to cover your funeral costs, daily living expenses, or their education.

    You'll also want to assign a contingent beneficiary who is second-in-line for the death benefits. The contingent beneficiary can be your parents, siblings, or even your business partner.

    Regardless of who you list as your primary and secondary beneficiaries, you shouldn’t list the bank or lending institution as your only beneficiary. The bank should lose the right to claim the death benefit from your insurance policy once your loan has been paid off, which won’t happen if you list them as a beneficiary instead of an assignee.

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    Final Thoughts

    Getting life insurance coverage comes with plenty of benefits. One of them is the ability to use your policy for a collateral assignment. This assures the lender that you'll be able to repay your debt to them, even if you pass away before your loan's maturity date.

    Written By Cameron McDowell
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