Lenders accept many forms of collateral. Find out if you can use life insurance to secure your business loan.
Coming up with collateral to use in backing a business loan can be difficult when you’re first starting out. The loan you’re looking for might be to merely get your business on its feet, or your industry might not include the valuable equipment traditionally used as collateral.
You have options to consider for collateral outside of equipment and real estate. Find out what you need to know about using life insurance as collateral for a business loan, including what to watch out for.
Can I use life insurance as collateral for a business loan?
The short answer is yes, some business loans accept life insurance as collateral. Some lenders for SBA loans even suggest that you have a life insurance policy to back it.
When you use a life insurance policy as collateral, you designate that the lender can collect some or all of the policy during the life of the loan. If something were to happen to you while there’s still a balance on the loan, the lender could make a claim against your policy.
What is collateral assignment of a life insurance policy?
Nobody likes to dwell on the inevitable. But you may be able to secure a business loan with your life insurance policy by completing a collateral assignment form.
This form doesn’t designate the lender as a beneficiary. Instead, it gives the lender a lien on the policy as long as there is a balance left on the loan you’re securing. Once the loan is repaid in full, life insurance rights transfer back to you.
Cautions to consider when securing a business loan with life insurance
As with putting down any collateral for a loan, there’s some risk associated with using your life insurance policy as security.
- If your loan has a balance, your family won’t get everything. In the event of your death, the lender gets first claim to your life insurance payout. Any remaining balance on your payout goes to your beneficiaries, but there could be nothing left, depending on the amount of the loan.
- Your loan approval could depend on your policy. If you sign up for an SBA loan that requires a life insurance policy, you may not get your funds until you provide proof of your policy.
- You may need to surrender your policy. Default isn’t something you plan on, but it can happen. Should you default on your loan, your life insurance plan would be cashed out for its worth and you’d still owe any remaining difference to the lender.
Tips on choosing the right life insurance policy
Here’s what to consider when deciding on a life insurance policy:
- How long you need the policy. If you want life insurance over the life of your loan only, make sure you look at term policies. Term plans generally limit you to 10, 20, 30, 40 or 50 years.
- How your health affects costs. If you’re a smoker or in a dangerous line of work, you’re considered at higher risk of death, which can bump up your rates. Make sure to choose a plan that fits your lifestyle.
- Whether your work provides coverage. If you work for a company outside of your business, your employer may offer life insurance. Even if it does, look into whether your insurance coverage continues after you leave employment.
- Fees and commissions. Whole life insurance policies are notorious for large commissions and fees. Don’t be afraid to ask questions to learn how much you’re really paying, including exactly what your payments fund.
- How much insurance you need. Coverage of $100,000 will cost less than coverage of $10 million, for example. Calculate how much coverage you’ll need so that you aren’t paying extra for unnecessary coverage.