When trying to secure a loan, the lender may ask you to provide something as collateral. If you do not have any other assets to use, you may be able to use your life insurance policy as the collateral needed for the loan. If your policy has a cash value, the lender may accept it for this purpose.
Life Insurance Cash Value
To use a life insurance policy as collateral for a loan, you must have a policy that accumulates a cash value. If you have a term life insurance policy, you only have a death benefit associated with your policy. You must have a whole life insurance policy, universal life or some other kind of policy that builds cash value with each payment you make.
To facilitate this type of arrangement, you must assign the benefits of your life insurance policy to the lender. This is known as an absolute assignment, and it allows the lender to receive the benefits from your life insurance policy. If you do not repay the loan, the lender can access the cash value of the policy to satisfy the debt. When your repay the loan, you can take back ownership of the life insurance policy benefits.
Besides having access to the cash value, the lender in this process is the beneficiary of your death benefit. If you die before repaying the loan, part of the money from the death benefit is used to repay your lender. You can make the lender a partial beneficiary if the death benefit is larger than the full balance you owe. The rest of the death benefit can go to another beneficiary.
Instead of using the cash value of the life insurance policy as collateral for a loan, you may be able to pursue a life insurance policy loan. With this arrangement, you borrow from the cash value of your life insurance policy. You borrow directly from the life insurance company and repay the money with interest over a certain amount of time. This prevents you from having to deal with another party, allowing you to work strictly with the life insurance company.