What You Need to Know Before Using Your Life Insurance Policy as Collateral

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Putting up your life insurance policy as collateral first requires an understanding of what collateral assignment entails.

By assigning any asset of yours as loan collateral, you’re legally pledging to give lenders proportional legal ownership of those assets in the event that you default on your loan.

Life Insurance as Collateral 101

In short, putting up your life insurance policy as collateral on a loan means that you need to be ready to lose it in the event that you can’t pay your loan back. Before anything else, you need to ensure that your policy’s necessary premiums are all met and paid throughout the loan’s term, and that your insurance company is notified of your intent. Investopedia explains that lenders readily accept life insurance policies as collateral because in comparison to other assets, it’s an agreement wherein it’s easier to guarantee the availability of funds —whether the borrower defaults or passes away before repayment. Under this agreement, if you die before you can repay the whole loan, the primary beneficiary of your life policy will be the lender, who will legally receive the amount you still owe via the death benefit. Only after the entire loan is accounted for will any differences then be given to other beneficiaries listed in your policy, the terms of which are detailed in our article on ‘Who Can Claim Life Insurance’. However, if you do pay the loan under the agreed-upon terms, the assignment is terminated and your policy is no longer listed as collateral.

Life Insurance as Collateral vs. Borrowing Against Your Life Insurance

It’s important to note that using your life insurance policy as collateral is different from taking out a loan against your policy. In an article on ‘Borrowing From a Life Insurance Policy’, The Balance details that doing this entails borrowing from your insurance company itself. In this case, as the lender, the company uses the cash value of your policy as the collateral for the loan. Similarly, defaulting on this loan entails the lender to deduct benefits from your policy in proportion to the amount owed. The main thing to watch out for here is that the compounding interest that may result from defaulting can balloon beyond your policy’s cash value over time.

Alternative Collateral Assignments

Apart from your life insurance policy, other assets that are viable for collateral assignment depend on the type of loan, your location, and many other factors. Property or real estate is the most widely accepted form of collateral. The most common example of this are hard money loans, which Private Lender Group chairman John Hornik defines as a way for an individual or a company to turn almost any real estate asset into cash. Meanwhile, alternative loan options look to use more common assets as collateral, with the exact terms often depending on your location. Title loan providers in Columbus, Ohio use what’s known as a lien on the vehicles of those who take out loans. The lien designates only the ownership of the vehicle itself as collateral, as borrowers are still allowed to keep using their cars. This is seen as an efficient and short-term solution to raise funds fast compared to a using your life insurance policy as collateral.

Some lenders even accept yet-unpaid business invoices are collateral, which allows them to collect invoices on behalf of businesses that have defaulted on loans. This type of collateral assignment might soon expand, as Sunnyvale-based fintech company Crowdz launches a new invoice financing system that’s hinged on blockchain technology. Through the Ethereum blockchain, the system allows businesses to digitally submit invoices to the marketplace for investment or financing, which could pave the way for blockchain-based invoices to be assigned as collateral for future business loans.

These are the options and considerations you need to carefully weigh before deciding to use your own life insurance policy as collateral. If you’re sure that you’ll be able to stick to loan repayment terms, then you won’t have any problems using your policy or any other assets as collateral. However, if you see any potentially significant bumps in your long-term loan repayment plan, it could be wiser to reassess which other assets of yours can be used as collateral instead of your policy.

 

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