How to Use Term Life Insurance As Collateral for a Loan

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Loan collateral protects a lender from financial harm in the event a borrower defaults on the original agreement. The lender outlines the collateral requirements as part of making a loan. In the case of notes secured by life insurance, the lender is assured of repayment in the event of the borrower's death. The most common method employed is a collateral assignment, where the policy becomes the sole property of the borrower once the debt is satisfied. Generally speaking, the assignment process is the same for both term and permanent life insurance policies.

Contact the lender to determine and discuss the exact terms of the assignment, including the loan's dollar amount, its duration and the rights and obligations of both lender and borrower. These rights and obligations address who pays the policy premiums, beneficiary modifications, death benefit payouts and default provisions.

Apply for a term policy if one is not already in force. The terms of the assignment and of the loan determine the length and face value of the policy applied for. Consider assigning an existing term policy if it conforms to the lender's specifications.

Obtain the appropriate collateral assignment form. Most major life insurance companies issue their own version. However, the American Banking Association also offers a document that is accepted by most financial institutions. Consult the lender and/or the insurer if uncertain which to use.

Complete the assignment document in accordance with its instructions and send a copy to the insurance company for official recording. The lender may also require a copy.

Tips

  • Remember to file a Release of Collateral Assignment form with the insurer once the loan has been satisfied.

    Consult an attorney or trusted business adviser for advice.