Using Life Insurance For A Loan: Is It Possible?

Life insurance can be a useful way to get a loan, but it's not without its risks. Borrowing against your life insurance policy can be a quick and easy way to get cash when you need it, but it's important to understand the specifics before taking one out. This option is only available if you have a permanent life insurance policy, such as whole life or universal life insurance, which has accumulated a cash value over time. Term life insurance, which is typically provided by employers, does not have a cash value component and therefore cannot be used to secure a loan.

The main benefit of a life insurance loan is that it offers convenient and fast access to cash without the need for a credit check or income verification. You can also avoid specifying the reason for the loan, giving you the freedom to use the money as you wish. Interest rates are generally lower than those for personal loans or credit cards, and there is no strict repayment schedule.

However, there are several risks to consider. If you don't make regular interest payments, your policy could lapse, and you may owe taxes on the amount you borrowed. Additionally, if you pass away before repaying the loan, the outstanding balance and interest will be deducted from the death benefit, reducing the amount your beneficiaries receive.

What types of life insurance policies can you borrow from?

Borrowing from your life insurance policy can be a quick and easy way to get cash in hand when you need it. However, it is important to note that you can only borrow from certain types of life insurance policies.

Whole Life Insurance

You can borrow against a whole life insurance policy. Whole life insurance policies are more expensive than term life insurance, but they have no predetermined expiration date. As long as sufficient premiums are paid, the policy will remain in force for the lifetime of the insured. While the monthly premiums are higher, money paid into the policy that exceeds the cost of insurance builds up a cash value that is part of the policy. This cash value is designed to offset the rising cost of insurance as you age, allowing premiums to remain level throughout life.

Universal Life Insurance

You can also borrow against a universal life insurance policy. Universal life insurance is another type of permanent life insurance that is designed to provide coverage for your entire life. The cash value portion of a universal life insurance policy either earns interest or is tied to an investment account or index, allowing you to grow the money over time.

Variable Universal Life Insurance

Variable universal life insurance is a type of permanent life insurance that includes a savings component. The cash value in a variable universal life insurance policy is invested by the owner in the stock market and grows accordingly.

Term Life Insurance

It is not possible to borrow against a term life insurance policy. Term life insurance is a low-cost option that is designed to protect people during a specific period of time, such as their working years. Term life insurance policies do not have a cash value component, so there is nothing to borrow against.

How does a life insurance policy loan work?

A life insurance policy loan is a loan taken out against the cash value component of a cash value life insurance policy. Policy loans come in the form of direct loans or indirect automatic premium loans.

With a direct loan, you borrow money from yourself, with the policy's cash value serving as collateral. This means there is no need for a credit check or income verification, and you can use the money for anything you like. The insurance company will charge interest, known as a spread, on the loan. This is usually very low, ranging from 0.25% to 2%.

Automatic premium loans (APL) allow the insurer to use your cash value to pay your life insurance premiums if you don't. Interest is added to the balance, often at unfavourable rates, and if policyholders are unaware, APLs can grow and erode the cash value, causing a policy lapse.

The amount you can borrow depends on the cash value of your policy. Each insurance company has different rules, but you can usually borrow around 90% to 95% of the cash value.

There is no fixed repayment schedule with a life insurance policy loan, but it is in your best interest to pay it back as soon as possible. If you don't make regular payments, your policy will be in jeopardy of lapsing, especially if the amount owed exceeds the policy's cash value. If you die before repaying the loan, the amount owed, plus interest, will be deducted from the death benefit, leaving your beneficiaries with less money.

Life insurance policy loans can be a quick and easy way to get cash, but they also come with risks. While they have low-interest rates and flexible repayment terms, they can reduce the death benefit and put your policy at risk of lapsing.

Pros and cons of borrowing from your life insurance policy

Borrowing from your life insurance policy can be a quick and easy way to get cash in hand when you need it. However, it is important to consider the pros and cons of doing so.

Pros

• No credit check required: Since you are borrowing your own money, no formal credit check is needed to qualify for a policy loan.
• Low-interest rate: Policy loans are a low-interest financing option, with interest rates ranging between about 5% and 8%, depending on whether they are fixed or variable.
• Flexible repayment: There is no formal repayment timeline, so you can make payments toward the balance as it fits your budget and cash flow.
• Cash value keeps growing: Your policy's cash value simply serves as collateral, so the funds continue to sit in your policy and gain interest.

Cons

• Minimum cash value required: You need to have sufficient cash value before you can take a loan. So if your policy is fairly new, it could take years to build up a decent cash value amount.
• Borrowing amount limited: You can only borrow up to a certain percentage of your cash value (usually around 90% to 95%). If you need to borrow more, you may have to explore other, potentially more expensive financing options.
• Reduced death benefit: If you don't repay your loan before you die, it will be deducted from your beneficiary's death benefit.
• Risk of lapse: Interest will continue to accrue, and the insurer will still make charges for policy expenses. If the balance of your loan grows past the policy's cash value, the policy could lapse, and you would have to make additional premium payments to keep it in force.
• Possible tax consequences: If your policy lapses before the loan is fully repaid, you could owe income tax on some of the money you haven't paid back.

How to borrow from your life insurance policy

Borrowing from your life insurance policy can be a quick and easy way to get cash. However, there are a few specifics to know before borrowing. Here is a step-by-step guide on how to borrow from your life insurance policy:

Check your policy type:

Permanent life insurance policies, such as whole life insurance or universal life insurance, allow you to borrow against the cash value of your policy. Term life insurance, on the other hand, does not have a cash value component and therefore does not allow borrowing.

Ensure your policy has a sufficient cash value:

It usually takes a few years for your policy to accumulate enough cash value to borrow against. The time it takes will depend on the structure of your policy, including premium amounts and performance if linked to investments. Contact your insurance provider to understand the minimum cash value required for borrowing.

Understand the terms and conditions:

Different insurers will have varying rules regarding borrowing. In general, you can borrow up to 90% of your policy's cash value. Contact your insurance agent to understand the specific terms, including interest rates and repayment terms.

Weigh the alternatives:

Policy loans are not the only way to access your policy's cash value. You may also be able to make a withdrawal or use the cash value to cover your policy premiums. Discuss these options with your insurance agent to understand the implications of each choice.

Consider the tax implications:

While policy loans are generally tax-free, there may be tax consequences if you do not repay the loan or if your policy lapses. Consult a financial advisor or estate planning attorney to understand the potential tax implications, especially if you are unable to repay the loan.

Develop a repayment plan:

Although policy loans do not have a strict repayment schedule, it is in your best interest to repay the loan as soon as possible. Develop a plan for repayment, including how often you will make payments and how much you will pay to stay on track.

Request the loan:

Once you have considered all the implications and developed a repayment plan, you can request the loan from your insurance provider. There is no approval process or credit check required, and you can use the money for any purpose.

Remember, borrowing from your life insurance policy can provide quick access to cash, but it also comes with risks. Be sure to carefully consider all the pros and cons before making a decision.

What to consider before borrowing from your life insurance policy

Borrowing from your life insurance policy can be a quick and easy way to get cash in hand when you need it. However, there are a few things you should consider before making this decision.

Firstly, it's important to understand that you can only borrow against a permanent life insurance policy, such as a whole life insurance or universal life insurance policy. These policies are more expensive than term life insurance but have no predetermined expiration date. If you have sufficient premiums, the policy will remain in force for your lifetime. Permanent life insurance policies build cash value over time, which can be borrowed against. On the other hand, term life insurance is a cheaper and more suitable option for many people, but it does not have a cash value component.

Another thing to keep in mind is that you need to have enough cash value in your policy to use as collateral for the loan. It can take several years for your policy to build up enough value to borrow against, and the minimum amount required varies by insurance company.

Unlike traditional forms of financing, policy loans do not require a credit check, employer verification, or income verification. Additionally, there is no mandatory monthly payment, and you are not required to specify the reason for taking out the loan. However, it is important to note that if you pass away before repaying the loan, the balance and any interest owed will be subtracted from the death benefit, resulting in your beneficiaries receiving a reduced amount.

While policy loans offer flexible repayment schedules, it is crucial to make regular payments to avoid interest accumulation. Interest on the loan balance is added if unpaid, which can cause the policy to lapse if it exceeds the policy's cash value. In such cases, you may owe taxes on the borrowed amount. Therefore, it is essential to have a solid repayment plan in mind and ensure that you can stick to it.

Lastly, consider the potential tax implications of borrowing from your life insurance policy. While the loan is generally tax-free, you may owe taxes if you terminate the policy or if the loan balance exceeds the cash value of your policy.

In conclusion, while borrowing from your life insurance policy can provide quick access to cash, it is important to weigh the pros and cons carefully and ensure that you understand the risks involved.

Frequently asked questions