When it comes to life insurance, many consumers find whole life insurance attractive because it typically offers a cash value amount. This feature may allow someone to use their life insurance as collateral for a loan or even take out a loan from their life insurance policy.
However, there are several factors that should be taken into consideration before going to the bank or your insurance Agent.
WHOLE LIFE INSURANCE AS COLLATERAL
There is a way for policyholders to use their life insurance policy as collateral for a loan by utilizing the value of the policy.
Collateral assignment
Depending on the state, collateral assignment occurs when a policyholder assigns the lender as the primary beneficiary of a death benefit. Meaning, if the policyholder dies or defaults on the loan, the bank would get the loan amount repaid by the money from the life insurance. Any other money left over would then go to the other beneficiaries.
There are a few requirements that must be met before this loan can be effective:
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The borrower must be the owner or an irrevocable beneficiary of the policy.
Now, this doesn’t mean the policyholder has to be the insured person. For example, a husband could be the borrower for a policy that insures his wife and vice versa. -
The policy must remain in force for the life of the loan.
Meaning, the policyholder must continue making premium payments on time for the full length of the loan. -
The insurance company has to allow collateral assignment.
Most whole life insurance policies are accepted for loans, but the company providing the insurance must allow the policy to be used as a loan. Term life policies may not be accepted because they do not accrue cash value and repayment terms may not match the term life insurance lifespan.
To protect the collateral of the loan, the policyholder may lose access to the cash value. However, if the loan is repaid before the policyholder’s death, the assignment is removed and the beneficiary goes back to whomever the policyholder chose, not the lender.
You must inform your insurance company of collateral assignment of a policy, but other than their obligation to meet the terms of the contract, the company won’t play a part in the agreement.
WHOLE LIFE POLICY LOAN
At retirement age (age 65), individuals are generally eligible for Medicare Part A – hospital insurance – and B – medical insurance (visit Medicare.gov to learn more about Part A and B coverage). Medicare, however, does not cover all hospital and medical expenses.
WHAT ARE THE ADVANTAGES AND DISADVANTAGES OF A WHOLE LIFE POLICY LOAN?
Before you decide to borrow from your life insurance policy, consider if this route is the best choice for your situation.
PROS:
- Short application process
- If you have built up cash value, you can borrow without a credit check
- Policy loans don’t appear on your credit report
- Policy loans may have lower interest rates
- Repay the loan on a schedule you and your provider set
- You can chose not to repay the loan and just deduct the amount due from the beneficiary’s benefit
CONS:
- Must have cash value built up which may take years from policy start date
- Risk a reduced death benefit for your beneficiary if loan is not repaid
- Risk losing your policy if the interest and unpaid loan amount total more than the remaining cash value
WHAT SHOULD I CONSIDER WHEN TAKING OUT A WHOLE LIFE POLICY LOAN?
If you do not want to endanger your life insurance policy, consider the following when taking out a loan.
- How will taking out this loan impact my life insurance policy? Will I put my beneficiary’s benefit at risk?
- Aside from the interest, are there any other fees or costs I need to know about?
- Consider creating a mock budget and schedule on how the loan will be paid back to ensure this is feasible.
A life insurance loan should be treated as a regular loan – with heavy consideration and an intentional payback plan. The primary reason for a life insurance policy is to help take care of your beneficiaries should something happen to you, and that could potentially be compromised if you were to default on the loan. Before taking out a policy loan, it may be best to speak with a financial advisor as well as a licensed insurance professional.
Resources:
- What is collateral assignment of life insurance? November 16, 2018 - Policygenius.com
- What is a Collateral Assignment of Life Insurance? May 31, 2019 - Investopedia
Categories: Insurance, Life Insurance, Whole Life Insurance