Using life insurance to cover debts
[social_share]Life insurance is a very effective way to secure lending, and to protect family dependants in the event of an unexpected death.
One of the biggest risks that any lender faces when deciding whether they should lend money is that the person to whom they are lending to could die. All debts that are owed by a dead person are put together and charged against that persons’ estate. All assets are then put together and the debts are then paid from these assets. If there is not enough money then the debts will not be paid off. Lenders may also find that their debts are challenged by other lenders or heirs to the estate, and they may find that even if there is enough money to pay that the money is tied up in illiquid assets such as a house and will take some time to release.
Life insurance is a relatively cheap way to get around this. Whereas many people will be uncomfortable about securing a loan on an asset that they own, or they may not have access to sufficient assets to secure against a loan, life insurance will cover the lender against the chances of not being paid. This will mean that life insurance will ensure that the person is able to borrow a larger amount of money at a lower interest rate than they would have otherwise done.
Life insurance on these types of loans is paid for by the borrower. This should be seen as a fee for the use of the credit, in the same way that the interest charged on the loan is. If there is a surplus on the life insurance after the loan has been paid off in most cases this will go to the estate, although this should be checked first.
Sometimes the life insurance is used as an investment vehicle to pay off a loan, particularly a home loan. The way in which this works is that the borrower takes out an interest free loan and then pays the repayment amounts to a universal life insurance policy. This relies on the investment returns being higher than the interest rate.
Another use for life insurance is protecting dependants if the person dies prematurely. This works in much the same way that life insurance works to cover other obligations such as school fees and the cost of renting a house.
