Using your life insurance policy as collateral is one way of securing a loan without the risk of using your home or car. Most loans are either secured or unsecured, and while an unsecured loan does not require collateral, they are not always the most affordable or available option to many loan seekers. Bankrate breaks down the collateral assignment of life insurance process along with alternative options to help you decide what type of loan may be best for you.

What is collateral assignment of life insurance?

A collateral assignment of life insurance is a method of securing a loan by using a life insurance policy as collateral. If you pass away before the loan is repaid, the lender can collect the outstanding loan balance from the death benefit of your life insurance policy. Any remaining funds from the death benefit would then be disbursed to the policy’s designated beneficiary(ies).

Why use life insurance as collateral?

There are several reasons why you might want to use life insurance as collateral for a loan. Among them:

• It can be affordable. Depending on your age, health, the type and value of policy, life insurance costs vary. However, life insurance premiums may be less than what you would pay for an unsecured loan with higher interest rates.

• You are not jeopardizing your personal property. By using life insurance as collateral, you might be able to take out a secured loan without putting your home or vehicle at risk. If you pass away before the loan is repaid, the lender will use funds available from your life insurance policy’s death benefit to pay off the loan.

• It may be attractive to lenders. Many financial institutions view life insurance as a good option for collateral, knowing that they will very likely have the money to pay off your loan in the event of your death.

Of course, there are also some situations in which a collateral assignment of life insurance is not the best option. Some people are unable to obtain affordable life insurance due to their age or health complications. It can also be difficult to use an existing life insurance policy as collateral for a loan; a lender may require you to take out a new policy, specifically for the purpose of the collateral assignment.

How do I take out a loan using a collateral assignment of life insurance?

If you would like to take out a loan using life insurance as collateral, your first step should be to find a lender willing to issue this type of loan. After you confirm the lender’s requirements, you may be able to use your existing life insurance policy (if the lender will allow it) or you might need to purchase a new policy for a collateral assignment.

If you take out a new policy, the application process is the same as applying for any other type of life insurance and may require extensive underwriting, including a medical exam. After you have purchased the new policy, you will need to ask the insurance company for a collateral assignment form that you will need to complete, noting your lender as an assignee. Generally, a lender will not be listed as a beneficiary. The beneficiary(ies)will be the person you would like to receive any leftover benefits not claimed by the lender.

What types of life insurance can I use as collateral for a loan?

Both main types of life insurance, term life insurance and permanent life insurance, can be used to secure a loan. If you have a policy that falls into a subcategory of permanent life insurance, such as whole life, universal life, variable life or variable-universal life, these too are eligible to be used as collateral. However, each financial institution will likely have different requirements. Make sure to discuss these requirements with your lender before purchasing life insurance with the specific intention to use it as collateral. If more than one option is available, you may want to compare the cost of premiums for each type of policy.

Alternatives to life insurance as collateral

If you are considering a collateral assignment of life insurance, there are a few alternative funding options that might be worth exploring. Since many factors determine each option, working with a financial advisor may be the best way to find the ideal solution for your situation.

Unsecured loan

Depending on your situation, an unsecured loan may be more affordable than a secured loan with life insurance as collateral. This is more likely to be the case if you have good enough credit to qualify for a low interest rate without having to offer any type of collateral. There are many different types of unsecured loans, including credit cards and personal loans.

Cash value life insurance

Some permanent life insurance policies accumulate cash value over time that you can use in different ways. If you have such a policy, you may be able to partially withdraw the cash value or take a loan against your cash value. However, there are implications to using the cash value in your life insurance policy, so be sure to discuss this solution with a life insurance agent or your financial advisor before making a decision.

Home equity line of credit (HELOC)

A home equity line of credit (HELOC), is a more flexible way to access funds than a standard secured loan. While HELOCs carry the downside of risking your home as collateral, you retain more control over the amount you borrow. Instead of receiving one lump sum, you will have access to a line of credit that you can withdraw from as needed. You will only have to pay interest on the actual amount borrowed.

Frequently asked questions

• • What is the best life insurance company?

    
    

    Finding the best life insurance company is important for you and your family. What works well for others might not fit your needs or current budget. First, find out how much life insurance you need by speaking with a financial advisor and using this life insurance calculator as a starting point. Similar to shopping for car insurance, you might want to look at customer service and claim reviews and the company’s financial stability ratings, then get quotes from several providers and ask for recommendations from people you trust.

  • What type of loans are collateral assignments usually associated with?

    
    

    Life insurance can be used as collateral for auto or home loans, but it is also commonly used for small business loans. Often small business owners have to use most of their private money to fund their businesses. When it is time to expand, upgrade technology or maybe hire more staff, they may need a loan to invest in their business that won’t put their remaining personal finances at risk.

  • What are other common forms of collateral?

    
    

    It is typical for borrowers to put up their real estate or vehicles as collateral since they are usually our most valuable assets. Some loan companies may accept cash in the form of money market accounts or certificates of deposit (CD), investments or valuable items such as jewelry, art and collectibles. Valuables are usually subject to an appraisal before they are accepted.