Most people don’t know that life insurance can come with many benefits besides those that first come to mind. It isn’t just a fund for beneficiaries in case the insured dies. It can be helpful during life just as well.
If you want to make any big purchase or investment today, the chances are that you’re going to have to apply for a loan. One of the main steps of taking out a loan is providing collateral.
Your collateral can be an asset you own, like personal property, including your life insurance. Some life insurance policies could be the best options for collateral.
We’re here to answer all of the questions you could have about the collateral assignment of life insurance. In this article, we’ll explain:
- What is a collateral assignment of life insurance?
- Why should you use life insurance as a collateral assignment?
- Which policies are best for a collateral assignment?
- How can you apply for collateral assignment of life insurance?
- How should you choose beneficiaries?
- What are the pros and cons of collateral assignment of life insurance?
- What are the best alternatives?
- How to own your finances with Whole Life insurance?
We hope that this article will help you determine whether this is the right financial step to take.
What is a collateral assignment of life insurance?
A brief summary is, putting collateral of life insurance for a loan ensures that the lender receives funds to pay off the loan even if something happens to the insured.
This is the main reason why plenty of lenders prefer collateral of life insurance. Providing them with the proof of sure collateral, regardless of your fantastic credit score, is bound to make them approve your loan faster.
The lender, also known as the assignee, will get paid first if the policy owner dies. They’ll get the amount equivalent to the loan still owed, after which beneficiaries get the remaining balance of the death benefit.
You have to be the owner of the policy you’re using as collateral.
Your sole responsibility is to ensure that your existing life insurance policy stays current. You have to pay all of the premium payments on time. Otherwise, your lender will contact you and maybe even offer to pay for your policy obligations, although they’ll add it to your loan.
However, they could also surrender your life policy and get the cash value for themselves.
Additionally, you’ll have to notify your insurance company when you add a collateral assignee and also when you pay off your debt in full, after which collateral assignment becomes null and void.
Absolute assignment
Absolute assignment is a collateral assignment where the policyholder lets the lender have complete control over the policy. This way, the policy owner’s access is limited and the lender access is utter.
This means that your lender can change anything they want, including beneficiaries, although you’re still the one insured.
Conditional assignment
The key difference between the absolute assignment and the conditional assignment has restrictions regarding the lender’s level of control.
In this case, neither the policyholder nor the collateral assignee has complete power over the policy, but the contract defines it.
Why should you use life insurance as collateral?
There are plenty of reasons people want to use their life insurance policy as collateral for a loan.
When you opt to use life insurance as collateral, you’re not putting your property at risk, have a higher chance of getting a loan approved by lenders and use money responsibly.
Instead of putting your savings account or even your home on the line, you have the option of going the safer route. Additionally, even for those worth a million dollars, monthly premiums for the insured party aren’t that significant.
Also, most lenders prefer such insurance products as collateral because of the certainty that they’ll get their loan paid back even if the borrower dies, which can’t be sure for every collateral out there.
Another advantage is that, in the case of a policyholder’s death, the beneficiaries won’t have to bother with the leftover debt because it’ll be paid off to the lender first.
However, not everyone can get a quality life insurance policy they can use for collateral. This option isn’t as affordable for some people for various reasons, like their age and health, significantly affecting policy rates.
In some cases, lenders may even require you to start a new policy with insurance carriers just for the loan.
Types of life insurance policy you can use for the collateral assignment
You can use almost every type of life insurance policies as collateral for a loan, but that doesn’t mean all of them are the same.
Some policies are more advantageous when assigning them as collateral, which can even depend on the insurance companies and lenders you’ll be taking your loan from.
In addition to that, you need to check with your insurance company whether a collateral assignment is possible for your policy.
Here are the types of policies you can use for the collateral assignment.
Term insurance
Term life insurance is the most popular among those purchasing life insurance because it only lasts a set amount of years and is generally more affordable.
The usual term length for this type of policy is ten, twenty or thirty years. The beneficiaries can get the funds only after the policyholder’s death and it doesn’t have equity.
Since this policy doesn’t have cash value, the lender can only get to the funds in case of the policyholder’s death.
Permanent insurance
Unlike term insurance, a permanent policy last forever, or at least until someone stops paying the premiums.
With policies like Universal life insurance and Whole life insurance, you can build cash value over time, which is attractive to lenders. Your chosen life insurance provider will have sufficient data on this.
However, if you can’t pay your loan or premiums, the lender can access that cash and use it to settle your debt.
Second to die insurance
Married couples use this type of insurance to ensure that the death benefit gets paid to the other after one dies. In this case, two people own the policy, so they both need to approve the new assignee.
How to apply for collateral assignment of life insurance
This whole process is simple and similar to requesting any other type of loan with collateral. It’s relatively straightforward.
Applying through the bank
The first step you need to take is finding a lender to request a loan and checking whether they’ll accept your existing life insurance policy as collateral.
Some people use cars or IRA accounts as their collateral, but life insurance is probably better.
Most banks and lenders will readily accept your policy as collateral, but some may ask you to start a brand new policy with the life insurance company if your current one isn’t sufficient.
Applying through the insurer
Your next step is to check whether you’re permitted to use your policy as collateral with your life insurance company. Let them know about everything that’s happening. Your life insurance agent will supply you with the required paperwork. Not all insurance companies support this.
This paperwork, especially the collateral assignment form from the insurer underwriting, needs to be filled out by you, your lenders and the insurance company.
The main difference is that you’re not making your lender the policy’s beneficiary but instead naming them as an assignee. This makes you the assignor.
When they’re assignees, they don’t have control over your life insurance, its cash and other aspects of it. This is significant because giving complete control to your lender can result in misuse and manipulation, so it’s certainly something you should avoid.
Both applying for the loan and taking care of collateral assignments should be done at the same time.
Unlike with the collateral assignment form, when it comes to the documents between the lender and the borrower, you have the freedom of creating whatever deal suits both parties best.
The final step is just waiting to see whether your loan gets approved or not.
Choosing the beneficiaries
It’s fairly common practice for beneficiaries to be those close to you whose financial safety you’d like to ensure in case of your death. There can either be a primary beneficiary or co-beneficiaries.
Even if you’re taking out this life insurance policy as collateral, you should still name the listed beneficiaries you would usually name.
As mentioned before, in the case of the policyholder’s death, the lender will get paid their outstanding loan balance first, after which the beneficiaries will get the remaining funds.
You should always follow the rule to never assign your bank or any other lender as the beneficiary. In case of your death, the bank will have full access to your death benefit, and this contract is more substantial than any will.
Pros and cons of collateral assignment of life insurance
As you can see up to this point, utilizing your life insurance policy as collateral can have its benefits and deficiencies. Here are some of the most prominent pros and cons when it comes to taking this financial step.
Pros
Safety
Arguably, using the collateral of life insurance policy is your safest bet when it comes to loans.
Although most people tend to use personal property as collateral, that comes with a significant chance of losing said property to your lender if you can’t pay the loan back.
When using a collateral assignment of life insurance, you have more of a financial safety net.
Affordability
Depending on your age and health status, monthly premiums for a life insurance policy can be surprisingly low, whether term length or permanent. This is especially the case with term life insurance.
For example, most people thought that a $250,000 term life insurance policy would cost about $500 a year, while the reality is that it would cost you about $13 per month.
Lender’s interests
Going for a collateral assignment of a policy will make your loan more likely to get approved by many lenders.
This is because this kind of collateral also greatly protects the lender’s interest.
With this kind of collateral, they’ll be sure the loan will get paid back even in the worst-case scenario.
Cons
Limited use of cash value
Depending on your insurance company and the contract you create with your lender, you’ll likely have limited use of the cash of your permanent life insurance policy.
Limited use of death benefit
Even if you don’t state your lender as the death benefit beneficiary, which you should never do, they still get a portion of the funds — enough to pay back the loan. This means that your beneficiaries could get a significantly lower sum of the death benefit, depending on the time of your death.
Loss of policy control
You can quickly lose control of your policy and the lender will take over. Of course, this also depends on your contract with the lender and the insurance company. You could lose control of your policy if you don’t pay the premiums, after which lenders may even completely change your policy.
Hard to get insured
Getting affordable life insurance with adequate insurance coverage, rates and requirements for your loan isn’t as easy as it may seem. Applying for life insurance incorporates going through a required medical exam which could take weeks of waiting for issuing insurance carrier.
Alternatives
As with any financial decision, there are a couple of alternative routes you can go down if you don’t want to assign your policy collaterally.
Cash-value life insurance
If accumulating cash value is an aspect of your policy, borrowing from it can be an excellent way to secure a loan. This type of loan requires a lot of monitoring and tracking your payments to ensure you finish everything on time, so you don’t end up in even more significant debt.
In the next part of this article, we’ll teach you more about one type of this — Infinite Banking with Whole Life insurance.
Unsecured loan
If your credit score is good enough, you could be able to apply for a small private or business loan without needing to supply collateral assignments.
People with this option shouldn’t sign any collateral simply because any collateral will make this option less affordable than needed.
Surrender a policy
You can only go for this alternative if you have a life insurance policy with cash value. When you surrender a policy, you can use your cash value, but you’ll ultimately end your life insurance coverage and there won’t be any death benefits for your beneficiaries.
Own your finances
As you can see, the collateral assignment of life insurance policy can have plenty of advantages and disadvantages. But one thing is always sure — you need to have absolute control over your personal finance.
One of the alternatives to the collateral assignment of life insurance is utilizing your insurance’s cash value, which we’d like to focus on.
We’re here to introduce you to the concept of Infinite Banking.
This concept utilizes your Whole Life insurance to ensure your financial freedom and get you other benefits.
Here are some of the essential information you should know about it:
The first step of Infinite Banking is owning a Whole Life insurance policy.
Infinite Banking is a strategic method for utilizing your life insurance to create an endless banking system. To put it in other words, Infinite Banking means being your own banker.
Owning an overfunded life insurance has many benefits, one of them being that you can borrow money from it using your policy’s cash value and repay it later. This way, you borrow money from yourself instead of a bank, and you pay it back to yourself with the rate of return, thus becoming your own bank, just without the fees usually involved.
Infinite Banking involves:
- Overfunding (with after-tax funds) a high cash value life insurance policy from a life insurance company.
- Accumulation of Cash Value (tax-free) throughout the years you are a policyholder of your life insurance policy.
- Tax-Free Loans taken out against your life insurance policy’s cash value to use for your financial expenses.
All of these aspects culminate in creating your own bank. You borrow from yourself while your life insurance policy still earns dividends even though you’re using those funds elsewhere.
No matter what your financial objectives are, Infinite Banking can help you reach them. Entering the Banking Business gives you better control over your finances and helps you build wealth using the life insurance policy.
Final thoughts
Collateral assignment life insurance is a complicated theme, with plenty of pros and cons. Hopefully, this article answers all of the questions you had about it. Remember to always contact your financial advisor before committing to big financial decisions!
When choosing a financial path you want to go down, it’s always best to investigate every possible alternative. In this case, we especially hope you’re interested in the concept of Infinite Banking with Whole Life insurance.
If you want to learn more about Whole Life Insurance and improve your personal finances, you can sign up for our premium membership! We are looking forward to seeing you at the Wealth Nation community!