Use your life insurance as collateral? Avoid these 5 common mistakes
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Did you know you can use your life insurance policy as collateral to secure a loan with a lender? Remember that the lender will receive the death benefit if you default on the loan or die before it is repaid. The remaining balance will be given to your beneficiaries if there is one. This arrangement is also only available on certain policies, such as term life, permanent life, and cash value loan. Learn how to avoid making common mistakes when borrowing against your policy. Borrowing More Than Cash Value
If your permanent life insurance policy is used as collateral for a loan, ensure that the cash value will cover it. If you dip below the cash value of your policy, your coverage will be lost and your beneficiaries will not receive any death benefits. Loans against the cash value also accrue interest. This is typically between 5% and 8% per year. Remember to take this into account when borrowing from your policy.
2. Failure to Pay Premiums
If your lender finds out that you have not paid your premiums or cancelled your policy, they may increase your interest rate or require repayment in full. The life insurance policy must be kept throughout the term of the loan. There may also be tax implications if you let the policy lapse with a loan that exceeds the total premiums. The IRS could classify this excess as taxable income.
3. Not Notifying Beneficiaries
Will your beneficiaries have enough to cover their expenses after the lender collects the remaining balance on your loan? Notify your beneficiaries about the loan. Particularly if the beneficiaries will only receive a reduced amount of benefit.
4. Use of a Term Insurance Policy without a Backup
If your policy is a term insurance, it has no cash value. If the term ends before the loan has been paid, your lender may require additional collateral or repayment. Using this as collateral is risky. You should include other collateral along with a term insurance policy, such as savings, real estate or other investments.
5. If you have used your life insurance policy as collateral for a loan, your lender will receive a collateral assignment. If you fail to remove your lender from your policy after your loan has been repaid, it could be difficult for your beneficiaries receive the death benefit of your policy without complications. The lender may still have a claim on your death benefit if you don’t remove them. Or, your beneficiaries may be required to prove the debt has been repaid. This could cause delays and additional legal steps.
Assessing How to Use Life Insurance as Collateral
Now that you know how to borrow against life insurance, it’s important to determine if this option is best for you. Life insurance can be a good option for lowering your interest rates and reducing the risk of other assets. Life insurance is often accepted as collateral by lenders. Read More
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