Collateral Assignment of Life Insurance (Explained)

Starting and growing any type of business requires some degree of capital—for real estate, inventory, office equipment, the list goes on and on. Not too many business owners have enough in their bank accounts to cover those expenses. However, using term life insurance as collateral can have some pitfalls.

The fact that you can use some types of term life insurance for business loan collateral is often overlooked. This article will help you think through whether using term life insurance as collateral for a loan is the best source of funding for your venture.

Unfortunately, qualifying for a loan doesn’t always come easy. Banks are hesitant to make loans to new and unproven businesses unless they can ensure their investment is protected. And, in most cases, loans to new businesses must have some type of collateral to ensure their loan will be paid back.

Of course, business owners usually consider life insurance to protect their businesses. Having life insurance to reduce business risk can protect your business if anything were to happen to key personnel. But, many business owners don’t realize their existing life insurance policies can be a source of collateral.

If you buy life insurance for business loan collateral, it can help get you the nod of approval from lenders by giving them some assurance you won’t default on your payments.

Don’t have life insurance yet? Use our free quote tool and get an optimized and affordable life insurance quote in seconds and then read on to see how you can use your life insurance to get a business loan.

How Life Insurance is Used for Business Loans: Collateral Assignment

When you take out a loan, the bank that provides the loan creates a repayment plan that can be spread out over a number of years. For the bank to make an investment in a new business, they will want to review your business plan and ensure that your business will make enough money to meet the repayment plan.

But what happens if a new business owner passes away before the loan is repaid? To protect the bank, prior to granting a loan, the bank may require that you assign as collateral the payout of a life insurance policy.

For term life insurance the bank will align the term of the policy with the term of the loan repayment. For instance, let’s say that you take out a $500,000/ 5-year loan to fund your business. The bank may require that you either purchase a new term policy or use an existing term policy for at least 5-years with a payout of at least $500,000.

It is important to understand that you are not putting the bank down as a beneficiary, but that you are assigning a payout to the bank if something were to happen. So, let’s say that you paid down $250,000. If you pass away before the remainder is paid, the $250,000 of the insurance payout will go to pay off the loan, and $250,000 will go to your beneficiary.

If you pursue this type of life insurance, you’ll need to sign a loan collateral assignment form to assign the bank as the recipient of the policy’s death benefit as long as the loan is in effect.

Usually, the bank will work with the insurance company to coordinate the execution of the form.

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What types of life insurance policies work for a collateral assignment?

Both permanent and term life insurance policy types can be used for collateral assignment of a business loan. However, as a business owner, it will be much cheaper to pay term life insurance rates for business loan collateral than those for a permanent life insurance policy.

Of course, you might have an existing permanent life insurance policy in place. With a permanent insurance policy, you may also have built up considerable cash value. Using a policy with cash value can make it easier for a bank to make a loan decision.

How to Apply for Life Insurance for Collateral Assignment

When you apply for a business loan, a bank may have certain requirements before approving your loan. One of the requirements might be that you have a life insurance policy in place to collateralize the loan.

If you have an existing policy, the bank will work with your insurance company to complete the collateral assignment paperwork. If you don’t have a policy in place, the bank will work with your insurance company to write a term life policy for the number of years that it will take to repay the loan.

You will still need to go through the formal application process for your life insurance policy, as well as complete a medical exam. If you are denied approval for your policy, you will also be denied the loan.

Because of this, it can save you time by having a policy in place before you apply for a loan.

Absolute and Conditional Assignment

When you apply for a loan, your bank will determine whether you should assign a life insurance policy with an absolute assignment or conditional assignment. In most cases, the type of assignment depends on whether the policy was written in order to get the loan, or whether you had a policy in place already that you would use to collateralize the loan.

If you already have a loan, you will want to conditionally assign the loan to the bank for repayment during the term of the loan. After the loan is repaid, the bank will no longer have a claim for the benefit.

However, if you took out a loan for the specific purpose of collateralizing your loan, you will likely be required to absolutely assign the loan to the bank.

Never Assign Your Bank as the Beneficiary

Remember, the bank is not a beneficiary of the policy, so do not assign them as a beneficiary. They will have a claim to the payout proceeds of the policy in the event of the death of the policyholder prior to the full loan repayment.

The last thing you want is for the bank to have a rightful claim as a beneficiary of the policy. This is because when a beneficiary is paid out, they are entitled to a percentage of the policy.  For a collateral loan assignment, you want the bank only to hold entitlement to the amount of the loan that is outstanding.

So, if a policyholder pays off more of the loan but dies during the term, the policyholder’s family will want to make sure the bank only gets the amount to pay off the remainder of the loan.

A Few Tips to Help You Get the Right Policy

1. Inform your agent or broker upfront that you need the policy as loan collateral. That way, they’ll know to prepare for the extra paperwork involved.
2. Take out a term life policy that’s long enough to cover the loan repayment period. For example, if you’re getting a 20-year business mortgage loan, you will need a 20-year term life insurance policy.
3. Don’t drag your feet! Because most lenders won’t finalize a loan until you’re able to show “proof of policy,” don’t wait until the last minute to talk with a life insurance agent if you don’t already have a policy. On average, it takes four weeks for policy approval. If you have medical conditions, the review process could take longer. Your bank may not want to wait that long.

Note that you can expedite the process of securing life insurance if you opt to apply for a no medical exam term life insurance policy. By going that route, you won’t have to take the paramedical examination otherwise required (if you do have to take the examination, understand what to expect from a life insurance medical exam here). These types of policies generally receive approval within 24 to 48 hours. The drawback is that they cost a bit more because the insurer is assuming more risk.

When to fill out collateral assignment paperwork?

If you are looking to secure funding by using life insurance for a SBA loan, you will need a policy in place first. The bank will want to make sure that you are in good health and can qualify for a policy.

Once you have a policy in place, the bank will review the rest of your loan application. If they choose to provide you a loan, the bank will then work with your insurance company to produce the assignment paperwork.

So, until you know that your loan will be approved, and your policy is in place, you don’t need to worry about assigning the policy.

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When does a collateral assignment end?

A collateral assignment will end when the loan is repaid. It’s as simple as that. However, the amount that the bank can claim reduces as you repay your loan.

So, if you took out a loan of $500,000 for a 10-year period, in the last year, the bank wouldn’t be able to claim $500,000 against the policy, but instead would discount the claim for the amount of principal that was repaid against the loan.

Pros & Cons of Collateral Assignments

Collateral assignment to secure a business loan does have benefits and disadvantages.
Pros:

• Term life insurance used to secure the loan is inexpensive. And as you pay off the loan, your family has an additional source of security.
• Using the insurance policy as a way to collateralize your loan allows you to free up other assets and cash flows to run your business.

Cons:

• If you have a permanent insurance policy, your access to use the cash value in the plan will be limited until the loan is repaid.
• Until you repay the loan, you may need additional life insurance to secure your family in addition to the policy used to secure your business.

In the end, however, most banks will require you to secure your loan with a policy. Keeping in good health and securing a policy while you are young will help you qualify for the lowest rates. Check out the rates below to get an idea of how much you might pay for a simple term life policy.

One last benefit is that your premium payments are an expense to the business and are tax-deductible.

Alternatives to Collateral Assignment

In some cases, you won’t have much of a choice but to take out an insurance policy to secure your loan. The bank will insist upon it.

However, you won’t have to if you use some other collateral for the loan. This could be real estate that you own, financial securities like stock and bonds, or simply a cash account with the amount available.

However, in each of these instances, you will lose flexibility in managing these assets since you will have to hold on to them for the life of the loan.  Also, you will need to manage the value of these assets. If they decrease in value, the bank may insist that you come up with additional capital.

If you are struggling to find a bank to provide you with capital, you can reach out to the U.S. Small Business Administration for helpful guidance on funding options.

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Using Life Insurance for Business Loan Collateral: The Bottom Line

If you have dreams for your business, and you need funding to help them come true, keep the option of a term life policy as loan collateral in mind as you talk with lenders.

Because of its affordability and flexibility, term life insurance can give the bank the assurance it requires without putting undue strain on your business budget.

The first step is to have a great policy in place at the best price. Start shopping right now by using our free quote generator. Get a custom term life insurance quote for business loan collateral in seconds and save time with the loan process later.

Collateral Assignment of Life Insurance: When Your Bank Wants Your Life Insurance

When your bank wants your life insurance, it’s because it will act as collateral for a loan. Not many people know that banks can ask for life insurance, among other documents, as collateral on a loan. Collateral assignment of life insurance is a sensible form of protection for the bank and is not a new practice at all. Refer to our guide to learn more about banks and collateral assignments of insurance.

Loan application… check. New business plan… check. Updated financial reports verified by your CPA … check. You’ve collected and submitted all the documents and requirements your bank has asked for and now it’s time to collect the cash and get to work. Or, so you think.

Today’s tight lending environment has seen a new trend emerge in business lending. Many banks now require life insurance coverage on borrowers, and possibly on guarantors as well. It’s a sensible form of collateral and protection for the bank and is not a new practice at all. In fact, it used to be common for lenders to require life insurance coverage on borrowers. However, it was also a huge hassle for the borrower. After all, years ago you couldn’t just run out and buy life insurance in a day.

But you can now.

Simplified Issue Term Life Insurance

Enter Simplified Issue Term Life Insurance, also known as No-Medical Exam term life insurance. It’s exactly what the name says it is and it comes in various forms, as life insurance companies scramble to get new products to the market. And the reason is obvious. Life insurance shoppers are buying it. Lots of it.

Simplified Issue Term offers the following benefits:

• No Medical Exam. Standard term life insurance requires a brief paramedical exam. While this is usually not a big deal to most people, it can be for people that are in a hurry or have a needle phobia.

• No Paper Application. The application is typically completed online or by telephone, with either an electronic or voice signature at the end.

• Reduced Wait Time. The entire process, from application to approval to payment, can be completed in as little as 15 minutes! Some applications can take a bit longer, up to 7-10 days. Compare that to regular term life insurance which has an average process time of 3-4 weeks.

Too Good to be True?

So what’s the catch? There isn’t one, but there can be some disadvantages, depending on your circumstances:

• Limited Coverage Amount. The highest amount currently available with any one life insurance company is $500,000. However, it is possible to ‘stack’ policies by purchasing from two or more companies. You just need to make sure you disclose all of your pending applications to each insurer.

• Cost. While not always more expensive, it is in many cases. This is the tradeoff for getting a limited medical review by the life insurance company.

• You May Not Qualify. The medical and background questions you must answer may disqualify you for simplified issue term. This does not necessarily mean you will be declined entirely. Based on your answers, you may be required to apply for regular term life insurance.

So, now you have a brand new term life insurance policy, and you’re ready to hand it over to your loan officer. All finished, right? Not yet. You will also need to complete the assignment paperwork to make the lender a beneficiary on your policy. This assignment establishes the lender as policy beneficiary for an amount equal to the payoff of the loan. Any additional proceeds from the policy after the lender has been paid will be paid to the beneficiary(s) of your choice.

If you are in the market for a business or personal loan, be sure to ask the lender if a life insurance policy as collateral will be necessary. The best thing you can do is shop for a policy early, just in case you can’t qualify for a simplified issue term life policy and you need to go the traditional route.

Case Studies: Using Term Life Insurance as Collateral for Business Loans

Case Study 1: The Start-Up Funding Boost

John, a budding entrepreneur, has a great business idea but lacks the necessary capital to bring it to life. He approaches a bank for a business loan but faces difficulty in securing approval due to the high risk associated with start-ups. However, John owns a term life insurance policy with a substantial death benefit.

By assigning the policy as collateral, John provides the bank with an added layer of security. In the event of his untimely demise, the bank will receive the payout amount to repay the outstanding loan balance. This reassures the lender and increases John’s chances of obtaining the necessary funding to kick-start his business.

Case Study 2: Expansion and Growth

Sarah owns a successful small business and is looking to expand her operations. She plans to apply for a business loan to finance the expansion, but the bank requires collateral to mitigate the risk. Sarah already holds a term life insurance policy and realizes she can leverage it as collateral.

By assigning her policy to the bank, Sarah demonstrates her commitment to repaying the loan. This collateral provides the bank with a safety net in case of unforeseen circumstances. It enhances Sarah’s credibility as a borrower and increases the likelihood of loan approval, enabling her to fuel the growth of her business.

Case Study 3: Mitigating Risk for Established Businesses

Michael runs a thriving business and wants to secure a loan for new equipment to improve efficiency. While his business is well-established, he understands that lenders prefer additional assurance before granting loans. Michael explores the option of using his existing term life insurance policy as collateral.

By assigning his policy to the bank, Michael showcases his commitment to meeting financial obligations. The collateral assignment ensures that the lender has recourse in the event of his unexpected demise, reducing the risk associated with the loan.

This gives the bank greater confidence in Michael’s ability to repay the loan and increases the likelihood of loan approval.

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