If you’re seeking to start a company or borrow money for another reason, your life insurance policy could be able to help get a loan online.
If the borrower passes away before the loan is paid off, the lender has first dibs on the death benefit, used to repay the debt. Any death benefits that are not used are given to the policy’s other beneficiaries.
“It’s a simple process.” “The life insurance is there, so the lender has less of a risk if anything occurs,” says Curtis Johnston, vice president and financial adviser at Girard in King of Prussia, Pennsylvania.
Borrowing money from your policy – a lending option if you have permanent life insurance such as a whole life policy with an accrued cash value — is commonly mistaken with using your policy as collateral for a loan. Although a life insurance loan is effectively a loan from yourself that comes with a low-interest rate, it is not without risk. Suppose you don’t repay the cash value withdrawn from the policy. In that case, the death benefit is reduced, and you may have to pay higher premiums if you were utilizing the policy’s cash value investment returns to offset your premium expenses.
Collateral assignment of your life insurance, on the other hand, has drawbacks. If you fail on the debt, the lender will be the first to receive the death benefit from your policy. As a result, it’s critical to comprehend this borrowing choice and learn how to mitigate its potential downsides.
Find out where the collateral assignment is most beneficial.
Although the collateral assignment may theoretically be utilized for a vehicle loan or mortgage, it is seldom necessary. The house or automobile that the loan is used to purchase might become collateral, and if the borrower fails, the lender can take the asset to repay the debt.
According to insurance professionals, collateral assignment is most prevalent in small—business loans and is a regular necessity. “Our bank is a favored SBA [Small Business Administration] lender,” Johnston explains, “and the SBA needs it on most agreements.”
Because most entrepreneurs invest the majority, if not all, of their money in their businesses, they may not have many other sources of capital to draw upon. Unlike a mortgage, which allows the lender to take possession of the property if the borrower fails, a failing business venture may not leave enough physical assets to cover the lender’s losses.
If an entrepreneur dies unexpectedly before their firm takes off, the lender may be left with an unpaid debt. (It’s also very unusual for lenders to demand that firms get life insurance on any leaders whose unexpected death might put the company out of business.)
Recognize which policies should be collateralized the most.
Gray explains that most business loans need you to obtain a policy designating your lender as a collateral assignee. “Term life insurance has traditionally been the most popular policy,” he adds, emphasizing the need to engage with an insurance professional who is familiar with the procedure. “It’s beneficial to utilize someone who has expertise dealing in these sorts of arrangements in these scenarios when companies and loans are involved,” he adds.
They’ll probably demand the policy’s term to be at least as long as the loan’s duration. “The easiest method to gain protection is to purchase an insurance policy for the duration of the loan,” Gray explains.
If you’re trying to use the value of your life insurance policy to secure a mortgage or other type of personal loan, the lender may prefer that you have a whole or permanent life policy with accrued cash value because the cash value turns the policy into a tangible asset, similar to a house or car, according to Gray.
“Using the cash value of a life insurance policy as collateral…that would be an asset,” he argues. “Because that cash is cash, whatever is in that insurance may be placed as collateral for [the loan].” As a collateral assignee on insurance without a cash value part, a lender would have no method of recouping their losses if you fail on the loan but don’t die.
Be aware of your other responsibilities.
You may be allowed to utilize an existing life insurance policy, or the lender may require the borrower to purchase a new approach for the collateral assignment.
You must maintain current on the premiums of the life insurance policy for which the lender is an assignee and not allow the procedure to expire, in addition to repaying the loan as stipulated in their agreement with the lender. According to Gray, staying current on the policy’s premiums is a requirement of the loan, and you may expect the lender to check. He replies, “It would be in the contract for them to keep the insurance.” “They usually ask for documentation every year or so.” They would be able to contact the insurance company for verification as the assignee.”
When the loan term expires, be ready.
The assignment expires when the debt is paid off, which means the lender no longer has a claim on your insurance policy and will need to give you a proof to prove it. If you do not get these documents, follow up until you do.
While the lender will no longer have a claim on your death benefit after the loan is paid off, if you die, your dependents may face a delay in receiving the death benefit if the insurer has to verify that the assignment to the lender has ended.
Choose the best policy recipient.
Making a lender a beneficiary of a life insurance policy rather than an assignee, according to Gray, is a frequent — and possibly costly — error. The lender receives first dibs on the death benefit money up to the existing debt with a collateral assignment, and any residual funds are parceled out among beneficiaries. However, if the lender is named the beneficiary, they will be entitled to the full death benefit, leaving the policyholder’s heirs with nothing.
“It’s something people should be wary with because it’s a circumstance that’s widely misconstrued,” Gray adds.