Collateral assignment of life insurance is an arrangement where you agree to give a lender the first claim to the payout from your life insurance policy. This allows your life insurance to serve as the collateral that many loans — especially small business loans or Small Business Administration (SBA) loans — require before they can lend you money you need.
In other words, the money from your life insurance payout helps the lender feel confident that they can collect the balance on your loan, even if you die while you’re still making payments. After the loan is paid off, anything left over will go to your loved ones.
How does a collateral assignment work?
Collateral assignment is an additional agreement to your life insurance policy that gives a lender first claim to your life insurance payout, but lets you name beneficiaries who can claim any money left over after the loan is paid. This is different from credit life insurance, which forces you to name your lender as the sole beneficiary of your policy. You can use either a term life or a permanent life insurance policy for collateral assignment.
If you already have a life insurance policy, and the death benefit is worth more than the loan you want to get, you may be able to use it as collateral. In other cases, loan companies that take life insurance as collateral may require you to buy a new policy that covers at least the full amount due.
Either way, the process of getting a policy is the same. You’ll go through the application and underwriting process, and wait to receive your offer. Then, you’ll complete paperwork to set up a collateral assignment.
Once you’ve paid off the loan, you’ll get a written release from the lender. The collateral assignment condition on your policy ends, but you can keep the policy active if you choose.
Learn more about how life insurance underwriting works
How do you apply for collateral assignment of life insurance?
There are a few simple steps to follow if you want to use life insurance as collateral for a loan.
Find a lender willing to use life insurance as collateral for the money you want to borrow.
Confirm the lender’s requirement and see if you can use any existing life insurance to meet it.
If that’s not an option, purchase a new life insurance policy.
Once your policy is active, ask the insurer for a collateral assignment form.
Complete the form and list your lender as the assignee.
Who should you name as your beneficiary?
When buying life insurance for collateral assignment, the process for setting up the policy is just like any other policy.
You’ll name your beneficiaries as you would for a personal policy (e.g., spouse, relative, or trust for children).
The lender is not your beneficiary; they are the assignee on the collateral assignment paperwork. You are the assignor.
Once your policy is set up, a collateral assignment will supersede your beneficiaries’ right to the death benefit.
If you die, the life insurance company pays the lender, or assignee, the loan balance. Any remaining benefit will go to your beneficiaries.
Who owns your life insurance policy?
Usually, the insured person is the policyowner and the payor on a life insurance policy. Some lenders may require an escrow account for the life insurance premiums; others may require proof of payment or prepayment.
If you’re using a permanent life insurance policy for the collateral assignment, a lender may have access to the cash value if you default on the loan.
Learn more about cash value life insurance
When should you fill out collateral assignment paperwork?
You only complete a collateral assignment agreement once a life insurance policy is active. After you pay your first premium, and sign your policy papers, you can request a collateral assignment form from the life insurance company or your insurance broker.
You’ll need your loan officer’s name and number for the form, as well as your policy number, Social Security number, and other personal information.
Once completed and signed by both the assignee and the assignor, you’ll file the collateral assignment form with the life insurance company and the lender according to whichever procedures they use for this process.
When does your collateral assignment end?
Collateral assignment ends only if:
You pay off your loan, or
You pass away.
Your lender must agree that the terms of your loan have been met and send a release to your insurer to terminate the agreement.
If your policy lapses — or you choose to cancel it — that could violate your loan contract. The lender may even make payments on your behalf to prevent a policy lapse. In that scenario, the lender adds the amount they pay to your loan total.
Collateral assignment pros & cons
Collateral assignment of life insurance has clear pros and cons. Review the following list carefully to decide if it’s a good option for you.
Pros
A collateral assignment enables you to secure business loans or other needed funds.
It’s less risky for a family than using a home or other essential property as collateral.
You can choose beneficiaries to receive any remaining death benefit funds.
Cons
The lender has first right to the death benefit, so your family may not get the benefit you intended.
Lapsing or canceling the policy could violate your business loan terms, causing problems with the lender.
You’re responsible for making payments until you die or the loan is paid off.
Alternatives to collateral assignment
Other ways to use a life insurance policy for debt repayment include the following options.
Life insurance loan: If you own a permanent life insurance policy, a life insurance loan allows you to borrow directly from your policy’s cash value. Any unpaid balance, plus interest, is deducted from your death benefit.
Cash surrender: The cash surrender value is the cash value built up in the policy minus administrative fees. Surrendering your policy cancels your coverage, so you’d need another policy for continued financial protection. You could also face penalties if you cancel during your policy’s surrender period.
Term life insurance: You should always buy enough insurance to cover your debts. On average, term life is much cheaper than whole life. Even if your lender doesn’t require collateral, your beneficiaries can use the death benefit to pay off your debts and keep the remainder.
For most people, term life is the most affordable and straightforward option to provide coverage for any outstanding loans when they die, with or without a collateral assignment attached.
If you need to use your life insurance policy for collateral assignment, the process is as simple as buying a policy and filling out the appropriate paperwork. Work with a licensed agent who can help you determine how much coverage you need and help you set up a collateral assignment.
