A collateral assignment of life insurance allows a borrower to use their life insurance policy as security for an existing debt. In some cases, when you apply for a loan, the lender may require you to buy a new life insurance policy or use an existing one as collateral. Under this security arrangement, if the insured dies, the policy pays the lender first, before paying the primary beneficiary or beneficiaries.

Adding a collateral assignment to your life insurance policy does not prevent you from naming life insurance beneficiaries, such as a partner or children, nor does it prevent your loved ones from receiving a financial benefit after your death. The collateral assignment simply specifies the order in which your life insurance payout is distributed.

How much of the death benefit can a collateral assignee take? A collateral assignment of your life insurance coverage only allows the bank or lender to claim the amount still owed on an outstanding loan or debt. If you have a $500,000 life insurance policy and die while still owing $50,000 on a business loan, the lender could claim $50,000 of your death benefit—assuming, of course, that you named that lender as a collateral assignee. If a lender is not a collateral assignee on your existing life insurance policy, it may still try to collect outstanding debts from your estate; it simply will not be first in line to receive your life insurance death benefit.

Talk to your financial advisor before establishing a collateral assignment. This arrangement can significantly affect how a policyowner's life insurance benefits are distributed, so make sure you have explored all your options and are willing to pledge your life insurance policy as collateral before signing any life insurance collateral assignment.

What Are Some Common Life Insurance Collateral Assignments?

• If you owe money to an institution or an individual, you can name them as a collateral assignee on your life insurance policy. Life insurance collateral assignments are generally associated with business loans and mortgages.
• If you are starting a small business and applying for a loan to help you get started, the bank may require you to pledge your life insurance policy as collateral. This helps the bank ensure it can collect the money you owe even if you die before repaying the debt.
• Similarly, people who need a little extra help when beginning the homebuying process might offer their life insurance policy as collateral for their mortgage.

Certain types of debt, such as student loans and credit card debt, are rarely secured through collateral assignments of life insurance coverage. However, this does not mean those debts disappear when you die. In fact, many people do not realize that most debts remain outstanding after death, and creditors will be well prepared to claim what they are owed.

Why Do People Create Life Insurance Collateral Assignments?

Since banks and lending companies will do everything they can to collect their money, whether or not you name them as collateral assignees on your life insurance policy, why would anyone sign a collateral assignment form?

When a lender requests a collateral assignment agreement, it means the lender suspects that your estate may not contain enough assets to cover your outstanding loan or mortgage. The lender wants the additional security of knowing it can collect from your life insurance policy if you do not repay your debts.

Life insurance collateral assignments become even more important if you have a whole life insurance policy with an associated cash value—money that can be withdrawn from the policy at any time. If you default on your debts, the assignee could claim your life insurance policy's cash value.

How Do You Create a Collateral Assignment on Your Life Insurance Policy?

In most cases, you cannot create a collateral assignment when applying for life insurance online. Instead, you complete an Assignment of Life Insurance Policy as Collateral form after receiving your new life insurance policy. Other people may have had life insurance coverage for years before finding themselves in a situation that requires a collateral assignment.

There is an important detail about the Assignment of Life Insurance Policy as Collateral form to keep in mind: it does not state the amount of money you owe the assignee. In other words, you are trusting your creditor to track how much you owe. As you continue paying down your debts, the amount you owe the creditor decreases, and the amount they should claim from your life insurance policy becomes smaller.

What Happens If You Need to Change Your Collateral Assignment?

Once you have paid the outstanding loan balance in full, what happens to your life insurance collateral assignment? The best step after paying off a mortgage, business loan, or other debt secured through a collateral assignment is to contact your life insurance company. Let it know that your outstanding loan debt has been paid and your life insurance policy should no longer be used as collateral.