Life insurance can sometimes help you qualify for a loan or secure a lower interest rate. With a collateral assignment, your policy is used to help protect the lender if you’re unable to repay the loan.
Not all lenders allow this, and there are trade-offs. The lender is paid first from the death benefit, which means your beneficiary is no longer first in line. Still, in the right situation, this approach can be a practical financial strategy. Below is what to know about assigning a life insurance policy and how it works.
What Is Collateral?
Collateral is a valuable asset used to secure a loan. When you borrow money, you agree to repay the lender through scheduled payments, usually with interest. This creates risk for the lender if the loan is not repaid.
By offering collateral, you give the lender the legal right to take that asset if you fail to repay the debt.
Common examples of collateral include:
- Real estate
- Vehicles
- Equipment
- Investment accounts
What Is the Collateral Assignment of Life Insurance?
A collateral assignment of life insurance lets you use a life insurance policy to secure a loan.
You start by purchasing a life insurance policy with a death benefit, or you may use an existing policy. After that, you complete a collateral assignment form with the lender. This gives the lender the right to use the policy’s death benefit to repay the loan if you don’t.
This repayment may happen if you:
- Default on the loan, or
- Die before the debt is fully paid
With a collateral assignment, the remaining loan balance is paid first from the death benefit.
You'll still name a primary beneficiary on the policy. However, with a collateral assignment, the death benefit is used to pay off the loan first if you die before the debt is repaid. Any remaining amount then goes to your beneficiary. Once the loan is paid off, the assignment ends, and the full death benefit goes to your beneficiary as usual.
Can You Use Any Type of Life Insurance?
It depends on what the lender will accept. While most policy types can be used in theory, lenders often have preferences.
Permanent life insurance - such as whole life or universal life - is commonly accepted because it doesn’t expire as long as premiums are paid. This gives lenders more certainty they’ll receive the death benefit. If needed, the lender may continue paying premiums and add the cost to the loan balance. Some permanent policies also build cash value, which can provide additional collateral.
Term life insurance has a set end date, which makes it riskier. If the policy expires before the loan is repaid, coverage ends. While some lenders may allow term policies, they risk losing the collateral if the borrower outlives the term and still owes on the loan.
What Are Some Examples Using Life Insurance as Collateral?
These hypothetical scenarios show how life insurance can be used as collateral in different situations.
Example 1: Mortgage Collateral
Steve wants to take out a 15-year mortgage for $500,000. He does not already have life insurance, so he purchases a 15-year term policy with a $500,000 death benefit. The policy is assigned as collateral until the mortgage is paid off. His daughter is listed as the primary beneficiary.
What happens next:
- Ten years later, Steve passes away with $150,000 remaining on the mortgage.
- The insurer pays $150,000 to the lender to cover the outstanding balance.
- The remaining $350,000 goes to his daughter.
Example 2: Personal Loan Collateral
Kristi takes out a $100,000 personal loan to start a business. She already owns a $300,000 whole life policy with $25,000 in cash value. She uses the policy as collateral for the loan.
What happens next:
- The business fails, and Kristi is unable to repay the loan.
- The lender takes control of the policy through the collateral assignment.
- The lender first uses the $25,000 cash value toward repayment.
- After Kristi’s death, the lender uses part of the death benefit to cover the remaining balance.
- Any leftover proceeds go to Kristi’s named beneficiary.
How Do You Set Up a Collateral Assignment?
The exact steps can vary by lender and insurer, but the process typically follows these five actions:
1. Review Your Lender's Requirements
Start by asking your lender if they allow a collateral assignment of life insurance. If they do, confirm:
- Which policy types they accept (for example, whole life only)
- Whether an existing policy can be used
- If a new policy is required for the assignment
2. Set Up Your Life Insurance Coverage
If you already have a policy and your insurer accepts collateral assignments, you may be able to use it. If you don’t have coverage - or the death benefit isn’t high enough - you would need to purchase a new policy. Check whether your lender works only with certain life insurance companies.
3. Complete the Collateral Assignment Forms
Request a collateral assignment form from your life insurance company. This form includes loan details such as:
- Loan amount
- Repayment schedule
- Lender information
Once you and the lender sign the form, your insurer can list the lender as the collateral assignee.
4. Finish Setting Up Your Loan
After the collateral assignment is in place, you and the lender complete the loan application process. Once approved, the loan funds are issued, secured by your life insurance policy.
5. Pay Off the Loan to End the Collateral Assignment
Make payments according to the lender’s schedule. After the loan is fully paid, notify your life insurance company. They will confirm with the lender and remove the collateral assignment. At that point, the full death benefit goes to your primary beneficiary - not the lender.
What Are the Benefits & Drawbacks of Assigning Life Insurance as Collateral?
| Pros | Cons |
|---|---|
| May improve approval odds by strengthening an application when credit or a down payment is a concern. | Reduces life insurance benefits since the lender has first priority, limiting cash value access and the death benefit. |
| Could lower the interest rate by reducing lender risk, which may help offset insurance premiums. | Adds an insurance-related cost because ongoing premiums are required. |
| Helps protect other assets by avoiding collateral like a home or vehicle. | No guarantee of approval, as health underwriting can raise costs or lead to denial. |
What Common Mistakes Should be Avoided When Assigning Collateral?
When using a life insurance policy as collateral, these common missteps can create delays or financial issues.
Not Confirming Lender Requirements
Some lenders only accept certain policy types or policies from specific insurers. If you skip this step, you could end up with a policy the lender won’t approve. That may force you to restart the insurance application process before moving forward with your loan.
Naming the Lender as the Beneficiary
If the lender is listed as the primary beneficiary, they are legally entitled to the full death benefit—even if it exceeds your remaining loan balance. A proper collateral assignment limits the lender’s payout to what’s owed, allowing any remaining benefit to go to your chosen beneficiaries.
Canceling the Policy Before the Loan Is Paid Off
A collateral assignment requires the policy to stay active for the life of the loan. Canceling early may trigger penalties, such as a higher interest rate or a demand for immediate repayment due to a contract breach.
Not Leaving Enough Coverage for Beneficiaries
Collateral assignment reduces the amount available to other beneficiaries, such as a spouse or children. Before proceeding, confirm you still have enough coverage or other assets to handle final expenses and support those who rely on your income.
What Alternatives Could You Use for Your Loan?
If you’re considering using life insurance as collateral, it may help to review other options first. Each comes with tradeoffs worth weighing.
Use Life Insurance Cash Value
If your policy has cash value, it may cover your current financial need. You can:
- Withdraw cash value, or
- Take a policy loan and repay it over time for future use
Both options reduce the death benefit, policy loans accrue interest, and withdrawals above the amount paid in premiums may be subject to income tax, so it may help to compare these costs with the interest charged by a lender.
Take Out an Unsecured Loan
You could borrow without using collateral. While interest rates are typically higher, this option may cost less overall—especially if you no longer need life insurance coverage. Compare the total interest cost with the cost of maintaining your policy.
Use Other Assets as Collateral
If you own a home, car, or investment account, you may be able to use those instead. Options include:
- Using a vehicle or investment account as collateral
- Borrowing through a home equity line of credit if you’ve built up equity
The main risk is asset loss if you fall behind on payments.
Find a Co-Signer
A co-signer may help you qualify if you’re struggling to do so on your own. This person agrees to repay the loan if you don’t, which reduces lender risk. However:
- Missed payments can damage their credit
- The co-signer is legally responsible for the debt.
Should You Consider a Collateral Assignment of Life Insurance?
A collateral assignment of life insurance may make sense if the following apply to you:
- You already have life insurance or are healthy enough to qualify for a new policy
- Your life insurance needs are already covered
- You don’t want to put other assets at risk or don’t have other assets to use as collateral
This option may not be a good fit if:
- You don’t have life insurance and may not qualify for an affordable policy due to health issues
- You have life insurance but don’t want to reduce the protection available to your beneficiaries
Before moving forward, it may help to speak with a financial professional. They can help ensure you compare this option with other borrowing choices and offer guidance based on your situation. If a collateral assignment makes sense, they can also help with the insurance application process.
Conclusion
A collateral assignment of life insurance can be a practical way to secure a loan while keeping other personal assets outside a lender’s reach. The trade-offs typically involve cost, coverage limits, and how much protection you want to preserve for your beneficiaries. Reviewing the details carefully and comparing alternatives can help you decide whether this approach fits your broader financial plans.
Evaluate if using life insurance as collateral aligns with your financial goals. Request a Free Life Insurance Quote
Footnotes
- Withdrawals may be subject to charges, withdrawals of taxable amounts are subject to ordinary income tax, and, if taken before age 59½, may be subject to a 10% IRS penalty.
- Interest is charged on loans, they may generate an income tax liability, reduce the Account Value and the Death Benefit, and may cause the policy to lapse
