Life Insurance: Benefits And Drawbacks Of Using Policy As Loan Collateral

Most lenders require individuals who are borrowing money to provide collateral for the loan they are getting. Collateral serves as a safety net for the bank in case the borrower is unable to pay back the loan. It is common knowledge that fixed deposits and homes can serve as collateral. Yet another way of providing collateral for a loan is through your insurance policy. In such a scenario, if the borrower dies before fully repaying the loan, the policy’s death benefit will first go towards reimbursing the lender. The remaining funds, if any, will go to the beneficiaries after the loan has been paid off.

There are multiple benefits of taking a loan by keeping your life insurance policy as collateral.

Secure funding- In the absence of assets like a house or FD, a life insurance policy can help you secure the funding it needs. People often consider such a loan if they urgently require a big sum of money.

No risk to assets- In case you are unwilling to risk your assets by putting them up as collateral, this can serve as a good alternative.

Avoid high-interest rates- There are lenders who extend loans without demanding collateral. However, those loans will usually have high-interest rates. With the life insurance policy as collateral, you can avail the benefit of loans that have cheaper interest rates. However, while there are benefits to placing your insurance policy as collateral, there are also downsides.

Puts beneficiaries at risk- A life insurance policy’s ultimate purpose is to secure the future of the beneficiaries left behind. However, if you die before paying off the loan, then the lender will take the remaining amount from your insurance policy’s death benefit, leaving a lesser share for your family members.

Tax liability- Life insurance proceeds are exempt from taxes in India. However, the capital yields on the invested cash value account may result in a tax liability.

The new policy may be required- Some lenders do not accept a life insurance policy as collateral may not allow you to use your existing policy as collateral. If so, you may have to buy a new policy and have your policy as a collateral assignment.

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