What is a Collateral Assignment?
With regards to life insurance, a collateral assignment is a loan agreement between a borrower and a lender in which the borrower uses a life insurance policy they own as collateral for the loan.
How collateral assignment works
When you need a loan, you can choose between unsecured and secured financing. Secured loans come with lower rates, but they require you to present collateral. The lender can collect that collateral if you default on the loan.
A collateral assignment allows you to put a life insurance policy that you own up as collateral for a loan. Many lenders like this option because it essentially guarantees that if you’re unable to pay back what you owe due to premature death, they can collect it from the life insurance company.
When you have fully repaid the loan, the collateral assignment terminates. At that point, the beneficiaries named in your policy will get the full death benefit distributed to them.
The benefits of collateral assignment
A collateral assignment gives you a way to make sure that the lender only gets repaid for what you still owe. With this agreement in place, they will receive whatever portion of your death benefit is necessary to cover the outstanding loan amount. But any leftover monies will get distributed to your beneficiaries.
If you simply name the lender as a beneficiary rather than establishing a collateral assignment, the lender gets the death benefit in full, regardless of how much of the loan you’ve already paid off. In other words, the collateral assignment allows you to repay your debts while leaving as much money as possible for your beneficiaries.
Collateral assignment with types of life insurance
Not all life insurance policies are eligible for collateral assignment. Many lenders only accept permanent life insurance policies because these policies will stay in force for the insured’s lifetime (provided the policy owner continues making premium payments). With term insurance, on the other hand, there’s no guarantee that the policy owner will want or be able to cover the inflated premiums that arise at the end of the policy term.
That said, if the loan you want comes with a term that’s shorter than the term on the life insurance policy you want to use as collateral, the lender may consider it.