Orlando Harmon
Borrowing against your life insurance policy can be a quick way to get access to cash. However, this is only possible in Canada if you have a permanent life insurance policy, such as whole life insurance or universal life insurance. These policies are more expensive than term life insurance but have no predetermined expiration date and allow you to borrow against the cash value of your policy. Borrowing against your life insurance policy can provide several benefits, such as quick access to cash and no impact on your credit score. However, there are also drawbacks, including the potential to lose coverage if you cannot repay the loan and the possibility of tax consequences.
| Characteristics | Values |
|---|---|
| Borrowing options | Borrowing is only possible if you have a permanent life insurance policy with cash value, such as whole life insurance or universal life insurance. Term life insurance policies do not allow borrowing. |
| Borrowing process | Contact your insurer to initiate the borrowing process. Approval is typically quick if your policy has sufficient cash value. |
| Credit score impact | Borrowing against life insurance does not affect your credit score or require a credit check since the cash value serves as collateral. |
| Interest rates | Interest rates vary by insurer but typically range from 5% to 8% per year, with an average of 6%. These rates are usually lower than credit card or bank loan rates. |
| Repayment flexibility | There is no set time limit for repayment, and you can choose a repayment schedule that suits your needs. However, interest will accrue on the loan balance, increasing the total amount owed over time. |
| Loan amount | The maximum borrowing amount depends on the insurer, but it is typically close to the total cash value, with most insurers allowing up to 90% to be borrowed. |
| Tax implications | Borrowing against life insurance is generally tax-free as long as the policy remains in force and the borrowed amount does not exceed the premiums paid. However, tax consequences may arise if the policy lapses or terminates. |
| Impact on death benefit | Borrowing against your life insurance will reduce the death benefit if the loan and interest are not repaid. The outstanding loan amount and interest will be deducted from the death benefit. |
What You'll Learn
Borrowing against a permanent life insurance policy
With a permanent life insurance policy, you can borrow against the cash value of the policy. This means that the insurer uses the cash value as collateral, and you borrow directly from them. The loan is not taken from the death benefit or cash value of your policy. Borrowing against your life insurance policy can provide quick access to cash without affecting your credit score, as there is no credit check or approval process. The interest rates on these loans are typically lower than those of credit cards or bank loans, ranging from 5-8%. Additionally, there is no set time limit for repayment, and the flexible terms allow you to pick a payment schedule that suits your needs.
However, there are some disadvantages to consider. It can take upwards of 10 years to build up enough cash value in your policy to borrow from. If you do not repay the loan, it will reduce the death benefit that your beneficiaries will receive. The interest on the loan will accumulate, and if it exceeds the policy's cash value, your coverage may lapse. Therefore, it is important to carefully weigh the pros and cons before deciding to borrow against your permanent life insurance policy.
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Pros and cons of borrowing against your policy
Pros of Borrowing Against Your Policy
- Quick access to cash: Borrowing money against your life insurance policy is a quick process. You fill out a form with your insurer and the money is typically deposited into your account within a few days, making it a great option for those looking to access funds quickly.
- Doesn't affect your credit score: Borrowing against your life insurance policy means no credit check, since the cash value is the insurer's collateral. This makes it an appealing option for those with low credit scores who may not be able to borrow money otherwise. It also means that this loan will not affect your credit.
- Flexibility in when you pay it back: There’s no set time limit for when you pay it back. That said, you’ll still want to consider paying the loan back promptly to avoid hefty interest charges.
Cons of Borrowing Against Your Policy
- You have to wait for cash value to build up: It can take a long time, often upwards of 10 years, for your life insurance policy’s cash value to build up enough for you to borrow against.
- You can lose your coverage if you don't pay: If you don't pay back the loan, the insurer will take it from your life insurance policy’s cash value. And when the cash value depletes, your coverage will lapse. If you pass away before paying the loan, the life insurance company will deduct the outstanding balance from the death benefit, meaning your loved ones will receive less money than intended.
- Your only options are whole or universal life insurance: If you want to take advantage of this option, you need to have a whole or universal life insurance policy in place. These types of policies are expensive and provide more coverage than most Canadians need, especially if your main reason for getting life insurance is to protect your financial dependents.
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Whole life insurance
However, it is important to note that borrowing against the cash value of a whole life insurance policy will result in interest charges, and unpaid loans will reduce the cash value of the policy or the final death benefit. There may also be additional tax implications for borrowing against the cash value.
Some additional benefits of whole life insurance include the potential for dividends and the ability to customise the policy with add-ons. Whole life insurance can also be used to protect assets and pass them on to future generations, as the death benefit can be used to pay any taxes associated with the estate.
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Universal life insurance
The two parts of a universal life insurance policy are the insurance and investment components. You choose your investment accounts, and growth can accumulate tax-free, within limits set by the government. You can withdraw or borrow from your policy, with certain tax implications. You can also choose who to leave your money to.
You pay a premium for your insurance coverage. After you’ve covered the insurance costs, the rest of the money goes to the policy’s investment part. The money goes toward investments of your choice. You can access the money in your account to use however you want, as long as there’s enough left to cover the insurance costs.
Benefits of universal life insurance include:
- Tax-preferred investing choices
- Guaranteed lifetime protection
- Flexible financial protection
- Lifetime coverage
- Tax-advantaged investing
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Policy loans
When you take out a policy loan, you are essentially borrowing from yourself, as the loan is secured by the cash value of your life insurance policy. There is no credit check or approval process, and the loan does not affect your credit score. You can use the loan for any purpose, and there are no restrictions on how you spend the money. The loan is also not subject to tax as long as the policy is still in force. However, interest will be charged on the borrowed amount, and this interest will accumulate over time.
Advantages of Policy Loans
Disadvantages of Policy Loans
One of the main disadvantages of policy loans is the potential impact on your life insurance coverage. If you do not repay the loan, the insurance carrier will deduct the outstanding balance from your policy's cash value or death benefit. This could result in a reduction in the amount your beneficiaries receive upon your death. Additionally, if the outstanding loan amount exceeds the cash value, your policy may lapse, leading to a termination of your coverage.
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Frequently asked questions
Yes, but only if you have a permanent life insurance policy like whole life or universal life insurance. Term life insurance does not have a cash value, so there is nothing to borrow against.
Borrowing against your life insurance policy means taking out a loan from the insurer, using the value your policy has built up as collateral. This loan is not taken from your death benefit or cash value.
Borrowing against your life insurance can give you quick access to cash without affecting your credit score. It also offers flexibility in when and how you pay it back. However, it can take upwards of 10 years to build up enough cash value to borrow from, and interest on your loan can reduce your policy's payout.
You can borrow against your life insurance policy as soon as it has built up enough cash value. This typically takes at least a decade.
This varies by insurer, but most companies allow you to borrow up to 90% of the policy's cash value.
