Collateral Assignment of Life Insurance to a Lender

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When most people think of life insurance benefits, they think of providing financial protection for their loved ones or using the cash value as an emergency cash fund.

Some life insurance products like indexed or variable universal life are now being used as retirement planning alternatives because they can build significant cash value over time.

Another purpose or solution that life insurance provides is helping the policyholder obtain financing for a loan. This process is called a collateral assignment and provides for the lender to receive a portion of the death benefit if you die while paying on a loan.

How Does Collateral Assignment Work?

First of all, it’s important to mention that any type of life insurance policy except for accidental death policies can be used for collateral assignment to a lender. It does not have to be permanent insurance but if it’s a term policy, the term should be for at least the length of the loan you are seeking.

For example, a 10-year term life insurance policy will not be adequate or accepted by a lender if the loan is for more than 10 years. In many cases, a borrower will choose cash value life insurance like universal life or indexed universal life as collateral because the cash value in the policy will continue to grow even though the death benefit has been collateralized.

It’s a simple process to assign the death benefit in your life insurance as collateral:

  1. You have a life insurance policy that you pay for and you are the named insured on the policy.
  2. You will apply for the collateral assignment with your insurance company and the lender who is asking for it.
  3. When your insurance company has approved the assignment of your death benefit, you should notify the lender and provide written proof of the collateral assignment.  This is usually handled by the insurance company.

Most lenders will allow you to use an existing policy if the following conditions apply:

  • The policy will remain in force for the duration of the term of the loan
  • The death benefit of the policy is sufficient to cover the loan
  • The policy is in your name and you are the owner
  • The insurance company is acceptable to the lender.

Some lenders may require a new policy (typically purchased through them) instead of allowing you to use a policy that you already have in force. Various lenders do life insurance collateral assignments differently but in most cases, it’s pretty straightforward.

Can the Death Benefit in My Policy be More than the Loan?

When your insurance company endorses your policy for the collateral assignment, they will add the following condition to the endorsement – “As their interest may appear.” This means that if your policy’s death benefit is $300,000 but the balance on your loan when you die is $225,000, the lender would receive the balance of the loan ($225,000) and your beneficiary would receive the balance. Additionally, the collateral assignment of your life insurance policy will survive if you default on your loan. So if your loan is in default when you pass away, the lender will receive the outstanding amount of the loan from your death benefit.

What Happens if I pay off the Loan Early?

As we mentioned earlier, your policy’s death benefit is assigned to the lender as their interest appears. This means when your loan is paid off, the lender will no longer have an interest and the death benefit will revert back to your beneficiaries in the full amount. Typically, the lender will notify your insurance company that they no longer have an interest in your death benefit or you can notify the insurer by sending them a copy of the statement showing your loan is paid in full.

Can I just add the Lender as a Beneficiary?

You can, but you should never do that. The collateral assignment to the lender is only as their interest appears. If you add them as a beneficiary, then they will be entitled to whatever share of the death benefit you have listed. This means that you would have to change their share each time the amount of your loan is reduced.

How will a Collateral Assignment Affect My Beneficiary?

If you die while your loan is outstanding, the lender with the collateral assignment would be paid first and then any remaining death benefit would go to your beneficiary or beneficiaries on a pro-rata basis.

Here’s an example of how your beneficiary or beneficiaries would be affected. Let’s say you have a life insurance policy with a $500,000 death benefit that you have listed your 3 children as beneficiaries to share and share alike. When you do a collateral assignment, the lender will be first in line for the death benefit if you die before your loan has been paid in full.

Your policy’s death benefit: $500,000

Loan balance when you die: $200,000

Balance to Beneficiaries to share and share alike: $300,000

Life insurance collateral assignment

 

Which Companies should I Use for Collateral Assignment Life Insurance?

It’s important that the insurance company you use for a collateral assignment to a bank or other lender is a highly-rated insurance company and acceptable to your lender. We recommend the companies listed below because of their financial ratings and competitively priced insurance products.

 

Lincoln Financial

Rating ServiceRatingComment
AM BestA+2nd Highest out of 16
Standard & Poor’sAA-4th Highest out of 21
FitchA+5th Highest out of 19
Moody’sA15th Highest our of 21

 

North American Company

Rating ServiceRatingComment
AM BestA+ Superior2nd Highest out of 16
S&P GlobalA+ Strong5th Highest out of 22
FitchA+5th Highest out of 19
Comdex Score92Out of 100

 

Midland National Life

Rating ServiceRatingComment
AM BestA+ Superior2nd Highest out of 16
S&P GlobalA+ Strong5th Highest out of 22
FitchA+5th Highest our of 19
Comdex Score90Out of 100

 

Allianz Life

Rating ServiceRatingComment
AM BestA+ Superior2nd Highest of 16
Standard & Poor’sAA3rd Highest of 21
Moody’sA15th Highest of 21
Comdex Score90Out of 100

 

The Bottom Line for Life Insurance Collateral Assignment

 

Although we find the collateral assignment of life insurance to a bank as a fairly simple process, you should choose an experienced and reputable independent insurance agent to handle this essential process to help you make certain your lender will accept the policy you have purchased. Our insurance professionals are very familiar with the collateral assignment process and will walk you through it every step of the way.

 

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For more information about Collateral Assignment Life Insurance, please call us at (800) 712-8519 during normal business hours or contact us through our website and we’ll be happy to discuss it.