Lender Requirements: When Banks Mandate Collateral Assignment on Business Loans
For small business owners seeking commercial financing, the bank often requires additional security beyond the business assets. In many cases, the bank will require the business owner to use their Permanent Life Insurance policy’s cash value as contingent collateral via a **Collateral Assignment**.
Why Banks Require Life Insurance
A bank requires this assignment for two reasons related to the business loan:
- **Contingency Plan:** If the business owner (who is usually the key to the business’s success) dies, the life insurance death benefit pays off the outstanding loan balance, protecting the bank’s investment.
- **Cash Value Security:** The cash value provides liquid collateral that the bank can access if the business defaults on the loan, ensuring a secondary source of repayment.
The Process and Impact
The bank only holds a lien on the policy up to the outstanding loan balance. Once the loan is fully repaid, the bank releases the assignment, and the policy returns to the full control of the owner/beneficiary. This process allows the policy to function as an off-balance-sheet asset for securing capital.
Disclaimer: This content is for informational purposes only and is not financial or legal advice. Consult legal and financial advisors to ensure the collateral assignment documentation meets all lender and policy requirements.