Life insurance protects a policyholderâs loved ones when they pass away. But life insurance may also come in handy during the policyholderâs lifetime if they want to apply for a personal loan. Â
Some lenders will allow a life insurance policy thatâs up to date on premium payments to secure a loan through a process called collateral assignment. If the borrower fails to make their loan payments, the lender will have the right to take money from the policy â the collateral â to recoup their losses. Â
What is the Cash Value of a Life Insurance Policy?Â
The cash value of a life insurance policy refers to the amount of money a policyholder would receive if they terminated the policy. Each time they pay for cash-value life insurance, like whole life or universal life insurance, part of their premiums go toward increasing the cash value. Â
Over time, the cash value grows at the interest rate outlined in the terms of the policy. Â
Reasons to Use Life Insurance for a LoanÂ
There are several reasons a borrower may want to use life insurance as collateral for a loan, including:Â
- To lock in a more affordable rate. Loans secured with collateral often have lower interest rates and better repayment terms than unsecured loans. Â
- To protect other belongings. Many borrowers assume that the only way to get a secured loan is to risk assets like a house or car. A life insurance policy is another option that they might prefer.Â
- To increase chances of approval. Borrowers who donât have the best credit may be more likely to get approved for a loan secured by the value of an eligible life insurance policy than an unsecured loan.Â
Risks of Collateral AssignmentÂ
While there are several benefits of taking out a secured loan backed by a life insurance policy, the borrower must be aware of the potential downsides. First and foremost, if the borrower fails to repay the loan or dies before repaying the loan, it will reduce the amount paid to their survivors. Also, some insurance companies might not allow policyholders to use their existing policy as collateral, so the borrower might need to purchase a new policy to use instead.Â
Alternatives to Collateral AssignmentÂ
Those who donât want to use a life insurance policy as collateral for a loan may explore alternative options, including:Â
- Life insurance loan: People with cash-value life insurance may borrow money directly from their insurance company using the cash value as collateral. In most cases, however, this is only an option once the cash value has met a certain threshold.Â
- Unsecured personal loan: An unsecured loan doesnât involve collateral like a life insurance policy. An applicant with a qualifying credit score may get approved for an unsecured loan without risking an asset. Â
- Home equity loan or home equity line of credit (HELOC): These products tap into a borrowerâs home equity, which is the difference between the value of their home and what they owe on their mortgage. While a home equity loan offers a lump sum of money upfront, a HELOC is a revolving line of credit.Â
- Policy cash-out: Depending on the type of policy, a policyholder may be able to cash out their life insurance as long as theyâve paid their premiums. Of course, this means they will no longer have a policy and will need to purchase a new one.Â
Bottom LineÂ
Some lenders will accept an eligible life insurance policy as collateral for a personal loan. But before opting for this route, itâs important to consider the pros and cons. Itâs also a good idea to consider alternative borrowing options that might make more sense for their individual situation. Â
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About OneMain FinancialÂ
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