Life insurance as a guarantee | Money
If you’re trying to start a business or borrow money for other purposes, you may be able to take advantage of an unexpected source: your life insurance policy.
The way this works is called a collateral assignment. The arrangement “is a lien, in essence, against the proceeds of an insurance policy,” says Michael E. Gray, Jr., owner of MEG Financial in Pensacola, Florida. If the borrower dies before the loan is paid off, the lender gets the first dibs on the death benefit to pay off the outstanding loan balance, and any remaining death benefit goes to the other beneficiaries of the policy.
” It is very simple. This life insurance is there so that if something does happen it is less of a risk for the lender, ”says Curtis Johnston, vice president and wealth advisor at Girard, based in King of Prussia, Pennsylvania.
Using a policy as collateral for a loan is sometimes confused with borrowing money from your policy – a loan option if you have permanent life insurance such as a whole life policy. which has an accumulated cash value. While you mostly borrow from yourself as part of a life insurance loan, and at a great rate, moving isn’t without potential risks. Failure to repay the cash value of this policy reduces the death benefit and could mean higher premiums if you used the invested returns of the policy’s cash value to offset the costs of your premiums.
Having said that, there are also drawbacks to collateralizing your life insurance. If you do not repay the loan, the lender will have the first right to the death benefit under your policy. It is therefore essential to understand this borrowing option, and to learn how to minimize its possible drawbacks.
Find out where warranty assignment is most useful
In theory, an assignment of collateral can be used for a car loan or mortgage, but it is often unnecessary. With such a loan, the house or car that the loan helps to buy can become the collateral; If the borrower defaults, the lender can seize the asset to repay the loan.
Assignment of collateral is the most common – and is a common requirement – in small business loans, insurance professionals say. “Our bank is a privileged SBA [Small Business Administration] lender and the SBA require it on most transactions, ”Johnston said.
Since most entrepreneurs invest most if not all of their savings in their businesses, they may not have many sources of equity left to tap into. Unlike a mortgage, which allows the lender to take ownership in the event the borrower defaults, a failed business venture may not leave enough tangible assets of value for the lender to recoup its losses.
If an entrepreneur suddenly dies before their business starts, the lender could end up with a loan that will never be repaid. (It is also not uncommon for lenders to require companies to carry life insurance for any executives whose sudden death would put the company at risk of bankruptcy.)
Understand which policies are best guaranteed
If you must have a policy designating your lender as the assignee as collateral in order to get a business loan, Gray says most of these arrangements involve some type of life insurance. “Traditionally, the most widely used product has been term life insurance,” he says, adding that it’s important to work with an insurance professional who is familiar with the process. “In those situations where businesses and loans are involved, it helps to bring in someone who has experience in these types of transactions,” he says.
They are likely to require the term of the policy to be at least as long as the term of the loan. From a lender’s perspective, “the best way to get protection is to get the insurance policy for the life of the loan,” says Gray.
If you are trying to use the value of a life insurance policy to secure a mortgage or other type of personal loan, the lender might prefer if you have a whole or permanent life insurance policy with a value of. accumulated cash surrender – This cash value makes the policy a tangible asset, such as a building or vehicle, Gray says.
“In terms of using the cash value of life insurance as collateral… that would be an asset,” he says. “This money is money, so anything in this policy can be pledged against [the loan]. “If you default on the loan but don’t die, a lender would have no way of recouping their losses as an assignee on a policy with no cash value portion.
Know your other obligations
If you already have a life insurance policy, you may be able to use it, or the lender may require the borrower to take out a new policy for the assignment of collateral.
In addition to repaying the loan as agreed in their agreement with the lender, you are also required to keep abreast of the premiums of the life insurance policy of which the lender is an assignee and not to let the policy expire. Keeping up to date on this policy’s premiums is a condition of the loan – and you can expect the lender to check, Gray says. “It would be in the contract for them to maintain the insurance,” he said. “Usually they require proof every year or so. As the assignee, they would be allowed to appeal to the insurance company for verification.
Be ready when the loan ends
When the loan is paid off, the assignment ends, which means the lender no longer has a claim on your insurance policy, and the lender will need to provide you with documents to prove this. If you don’t receive this documentation, follow up until you have it.
While the lender still has no claim to your death benefit after the loan is paid off, if you were to die there could be a delay in your beneficiaries receiving the death benefit if the insurer needs to verify that the assignment to the lender terminated.
Choose the right beneficiary for the policy
Gray says that a common – and potentially very costly – mistake is to make a lender a beneficiary of a life insurance policy rather than an assignee. With an assignment as collateral, the lender first receives the death benefit money up to the amount of the unpaid debt, and then the remaining funds are distributed among the beneficiaries. If the lender is the beneficiary, this would entitle them to the full death benefit, which could leave the policyholder’s heirs with nothing.
“This is something people need to be careful about because it is an often misunderstood situation,” says Gray.
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