How to use Life Insurance as Loan Collateral?

Life insurance pays out a death benefit to your loved ones when you pass away. However, it can also be used for other purposes.

A permanent life insurance policy, such as whole life insurance, accumulate cash surrender value that can be used as collateral assignment for a loan. Lenders may allow you to borrow 80% to 100% loan-to-value if you offer your policy as collateral assignment.

The cash surrender value component transforms your policy into a tangible asset, similar to a car or your home. If you default, the lender can recover the loan amount from the cash value of your policy.

How to borrow from a life insurance policy?

Whole life and universal life insurance are two forms of cash value life insurance products. When you pay your life insurance premium, the insurer uses it for three purposes:
• To pay the cost of life insurance
• To cover various administrative fees
• To increase cash value and cash surrender value

The cash value of whole life insurance policy grows at a fixed rate determined by the insurer. With universal life insurance, you have control over how the cash value grows. The insurer allows you to select sub-investment accounts related to the cash value and cash surrender value from a pool of limited possibilities. You may earn a higher rate of return with the right investments. But, if the sub-accounts you choose do not perform well, you may quickly lose the majority of your accumulated wealth.

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The accumulated cash value can be accessed in the following ways:

Use it to secure a loan

You can borrow money using your life insurance policy, like universal life insurance, as collateral assignment. If you default, the lender can claim your cash value as an asset.
The amount of money you can borrow by pledging the policy as security varies per lender. Nonetheless, you may be able to borrow up to 100% loan-to-value in some cases.

Using a life insurance loan collateral assignment can provide you with much-needed funds, but the practice is not without risks. For example:

If you can't repay a loan, the lender subtracts the balance from your policy's cash value, reducing the death benefit. Each withdrawal directly decreases the benefit. For example, with a policy of $1 million face value and $100,000 cash value, if you default on a $50,000 loan, the lender reduces the cash value accordingly, so your dependents would receive $950,000, not the original $1 million.

Generally, you can borrow against your life insurance after it has been in place for a specified amount of time.

Take out a policy loan

A policy loan allows you to borrow money from the insurer while using the cash value of the policy as security. You can borrow no more than the current value of your policy. These loans are offered on a permanent life insurance policy, also as whole life or universal life policies, that have enough cash worth to borrow against.

The insurer will charge you interest on the loaned amount, which may be more than the interest rate charged by standard secured loans. But, they differ from other types of loans in one important way: you are not compelled to repay the borrowed money.

In other words, if you do not repay, your beneficiaries will. The insurance will recoup the money it loaned you in some way.

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Withdraw your cash value

You can withdraw money from your account at any moment, but you will be charged a fee each time. Keep in mind that when you withdraw money from the cash value, the death benefit is reduced dollar for dollar.

You can also withdraw the entire cash amount by surrendering the policy. In the insurance industry, "surrendering a policy" is synonymous with "cancelling it." When you surrender a life insurance policy, you receive the net cash value (actual cash value minus surrender charges) and the policy expires. If you pass away, your beneficiaries will receive no monetary compensation.

How much money can you borrow against a life insurance policy?

In general, you can borrow up to 90% of the cash value of your insurance by using it as collateral assignment. When selecting how much money to borrow, a third-party lender would analyze your specific situation, such as your creditworthiness and the cash value growth rate.

What Are the Benefits of a Life Insurance Collateral Assignment?

A collateral assignment form of life insurance can assist you in getting a loan. Lenders frequently make it a prerequisite for a business loan. The bank knows that if you pledge your policy to get a loan, it will not lose money if you default or pass away before repaying it.

How does using my cash value as collateral work?

When using cash as collateral assignment for a loan, you must name the lender as an assignee. If you are unable to repay the loan, the lender can cash in the policy to reclaim the lent money or wait until you pass away to get a portion or all of the death benefit as payback of the debt.

Why use life insurance as loan collateral?

Assigning life insurance as collateral assignment allows you to secure a loan without committing property or assets to the lender. If you fall behind on your payments, you may lose your life insurance coverage, which, while undesirable, may not be as severe as losing your home. You can also purchase another life insurance policy to ensure that your family receives a payout to help them survive after you die.

Will the proceeds of a life insurance policy loan be taxed?

You can get money tax-free if you borrow from a third party lender and use life insurance as collateral assignment. But, if you get a life insurance loan from your insurer, you must pay tax on the portion of the borrowed amount that exceeds your policy's adjusted cost basis (ACB). The same is true of policy withdrawals.

A life insurance policy's ACB is the sum of premiums paid less the net cost of pure insurance. For example, say you have a perpetual life insurance policy and pay $4,000 in premiums each year. The net cost of pure insurance is $1,000, with $2,500 used to grow cash value and the remaining $5,000 used to keep the policy in force. In this situation, the ACB of your coverage is $3,000.

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Pick the right policy beneficiary

A common — and potentially costly — mistake is to name the lender as a beneficiary of their policy rather than an assignee. If you identify the lender as an assignee, the lender will receive the amount owed from the insurance proceeds, with the remainder going to your beneficiaries. If, on the other hand, the lender is the beneficiary, it will receive the entire death benefit, which could be substantially greater than the loan sum. Also, your heirs will not be compensated in this circumstance.

Is a life insurance policy loan risky?

You can get funds for your business or personal requirements by using insurance as loan collateral assignment. But, there are some drawbacks to the relocation that you should be aware of.

The possibility of outliving your expected demise

Lenders base the loan amount not on your current cash, but on your estimated cash value at death, often allowing you to borrow up to 90% of it. However, if you live longer than anticipated, the lender might require early repayment or additional collateral assignment.

Interest rate and return rate assumptions

The lender sets your interest rate considering the growth rate. However, if the interest rate increases or your cash value underperforms, they may request early repayment or additional collateral assignment.

Still, despite risks, loans financed by life insurance are popular and often favored over traditional secured loans, which utilize personal assets as security.

Using Permanent Life Insurance as Collateral

If you have a permanent life insurance policy, you can use its cash value as collateral assignment to secure a loan. Borrowing against your policy, however, is not without risks. If you cannot make your loan payments, your loved ones may receive a reduced death benefit or no money at all when you die.

At Dundas Life, we recognize that making financial decisions can be difficult. That is why our team of specialists is here to assist you in using your permanent life insurance policy as collateral assignment.

Reach out to us today to find out how we can assist you in weighing the risks and benefits like death benefit and making an informed decision about your financial future.