Collateral refers to a property or other form of security that a borrower puts up in exchange for a loan. Collateral assignment of life insurance can be used as collateral against a loan. Should the borrower die while the loan remains outstanding, the lender gets to collect any amount due. The remainder of the funds is dispersed amongst the beneficiaries of the borrower’s estate.
Some lenders require the borrowers to use life insurance as collateral. The effect is the same as credit life insurance, in which you name the lender the sole beneficiary of the policy as part of the terms of the loan. This reduces the risk to the lender and ensures that the death benefit would cover any outstanding amount.
If a borrower already has a life insurance policy that has a death benefit greater than the amount of the loan, it may be possible to assign that policy as collateral, although some lenders mandate that borrowers purchase a new policy solely for the purpose of collateral assignment. Once the policy is set, the borrower requests paperwork to assign the policy as collateral for the lender.
#1. How do you apply for life insurance for collateral assignment?
The process is the same one that you follow to apply for a personal policy, because the policy must be active before it can be assigned as collateral. Term and whole (or permanent) life insurance policies can both serve as collateral. After you choose the provider and the type of policy, you go through review and underwriting, which can take up to six weeks.
If the need is urgent, instant decision and accelerated underwriting life insurance can work. Both of those forego the medical examination and provide the offer within a few days. For people who are in good health, this is often the better choice. However, borrowers with medical issues in the past will have to go through traditional underwriting.
#2. How does beneficiary designation work?
The process of choosing a beneficiary is the same as with any other life insurance policy. The lender is the assignee that you designate on the paperwork for collateral assignment once the policy becomes active. You, as the borrower, are the assignor. So, for example, if you list your spouse or children as your beneficiaries and the lender as the assignee, the lender would take proceeds from the death benefit in the amount owed, and the beneficiary would receive the rest, if there is money left over.
#3. Who actually owns the policy?
Just like with a personal life insurance policy, you own the policy and are responsible for making the premium payments. Some lenders may mandate a trust account for the premiums, while others may require prepayment or proof of payment. If you put up a whole life policy as collateral, the lender can access the policy’s cash value should you default on payments.
#4. When do you fill out the collateral assignment?
As soon as the policy becomes active – which means after you pay the initial premium, sign the paperwork and receive confirmation from the insurer, then you can request collateral assignment paperwork. Make sure that you have the loan officer’s name and phone number, along with your insurance policy number and other personal identification information.
#5. Does collateral assignment ever come to an end?
You have to satisfy your loan obligation before passing away to end collateral assignment. If you pay your loan off, the lender will send a release to your insurer. Should your policy lapse, or should you decide to cancel the policy, the lender could view that as a violation of the contract. In some cases, the lender might pay premiums for you to keep the policy from lapsing. If that happens, the cost of those premiums is added to your balance due to the lender.
#6. What are some other ways to use collateral assignment?
In the case that your lender does not mandate collateral assignment but you would like to leverage your policy to repay debts, there are other ways to proceed.
One is a life insurance loan, which permits you to borrow from the cash value of a whole policy. You must first accrue sufficient cash value to serve as collateral.
Another is a cash surrender, in which you cancel a whole life policy and take the cash surrender value, which is the amount of cash that has accrued, less any administrative fees.
A third possibility is term life insurance. The policies are often as much as 15 times cheaper than whole life policies, and your beneficiaries can use the funds to settle your debts and hold onto any remainder, which means no paperwork to deal with for collateral assignment. This is generally the clearest and most affordable option, but if collateral assignment is a requirement for the loan, the paperwork and process can be made simple. Like any loan, it is recommended to obtain independent legal advice before proceeding with collateral assignment of your insurance.