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Can a life insurance policy be used as collateral for a loan?

Important things to know...
  • Most whole life and term insurance policies can be used to secure loans.
  • It is critical to follow all the steps and guidelines required by the insurance company and the lender or the loan may be voided.
  • There is one other way to use life insurance to get a loan.
Typically, a life insurance policy can be pledged as collateral for a loan. You must be the owner of the life policy. You can use cash value life insurance and sometimes even term insurance as collateral for a loan.

Check with your insurance carrier to make sure they allow collateral assignment of the policy.

You will also need to verify that the lender will accept this type of collateral. If you have a whole life policy, you will usually need to pledge the cash value part of your policy, along with a portion of the death benefit. This means that you cannot borrow from the cash value for the duration of the loan.

Learn more about using your policy as collateral below and make sure to use our free comparison tool above! Just enter your zip code and start comparing rates for free today!

Why are life insurance policies used as collateral?

AdobeStock_74536541-1600x1600Many lenders use life insurance policies as collateral because they are concerned that if the borrower dies before a loan is paid off, they will never get full repayment.

With collateral assignment of the policy for the loan, if the insured dies, the lender can take the portion of the proceeds covering the loan and the remainder goes to the named beneficiaries.

If a borrower defaults on the loan, a cash value life insurance policy could have the cash value surrendered to pay the loan.

Sometimes lenders to small businesses recognize that there is a key employee or key person, without which the business may not be able to continue. When making a loan to the business, they want to insure their risk against the owner dying and the business collapsing.

If the owner dies prematurely, the loan is automatically paid off.

Who has priority over death benefits on a collateralized life insurance policy?

adobestock_86115954-1600x1600The lender has priority over the claims of beneficiaries if the loan is still outstanding.

They can take the unpaid balance before the beneficiaries get anything. Whatever is left over after the secured lender is paid, will be paid to the named beneficiaries.

Requirements When Using a Life Insurance Policy as Collateral for a Loan

  • The policy must be paid on a regular basis and be enforce for the duration of the loan. If it is allowed to lapse, the loan will usually default, and be due in full immediately.
  • Most lenders require that the premiums be paid 6 months in advance. They want to ensure that it stays enforce.
  • Lenders must be notified the collateralization process has begun.
  • The insurance company must be notified that the policy will be used as collateral. This involves a beneficiary change. The lender becomes the primary beneficiary.

Things to Remember with Collateralizing

  • The assignment cannot take effect before the insurance company has accepted the assignment.
  • If there are existing loans against the cash value, they take precedence over the new loan.
  • The lender will be notified of a lapse in coverage.
  • The insurance company is not responsible for the validity of the assignment or any other legal issues regarding the matter. They will just put through the assignment.
  • The lender will require an official letter from the insurance company, stating that the policy is enforced and has no loans against it. If it does have loans, they will want details.
  • If the insurance company requires the original policy to make a claim, you will have to physically give the policy to the lender.
  • After the loan is paid, the lender’s attachment to the policy is terminated and the policy returned.

There is a Way to Borrow from Your Life Insurance Without a Bank

adobestock_56116135-1600x1600If you have a whole life policy that has accumulated cash value over the years, you can simply take the loan from the insurance carrier using your policy as collateral.

This method of borrowing is a lot simpler than going to a different lender, like a bank. You do not have to qualify for the loan or go through any of the detailed steps mentioned here.

One disadvantage to taking a loan this way, is that you will be charged a higher rate than you would pay on a loan currently. You would pay anywhere between 5 – 8 % for the loan. If you did not pay the interest, it would be added onto the loan amount.

In conclusion, you now know that you can use life insurance policies as collateral for a loan with most insurance companies. There are a some who won’t allow it, but only a few.

You must be the owner of the policy to assign it. It must be kept enforce or your loan may default. You are responsible for keeping the policy active, by paying the premiums. You can also borrow the cash value of your policy directly from the insurance company.

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