Borrowing Against Afba Life Insurance: Is It Possible?

The Armed Forces Benefit Association (AFBA) offers life insurance to active-duty military members, retirees, veterans, and their families. The AFBA was founded to address a critical need to support military members when commercial companies refused to pay life insurance benefits if a servicemember died in combat. The AFBA's life insurance member benefits are underwritten by 5Star Life Insurance Company, which was established in 1996 to provide coverage tailored to the unique needs of service life. While the AFBA does not explicitly mention borrowing against life insurance, it is worth noting that life insurance policies with a cash value component generally allow policyholders to borrow against their policy.

Pros of borrowing against life insurance

Borrowing against your life insurance policy can be a quick and easy way to get cash in hand when you need it. Here are some advantages of borrowing against life insurance:

No taxes

Most of the time, life insurance loans are not recognized by the IRS as income, so you won't have to pay taxes on them. However, this depends on the plan's details, so it is recommended to discuss this with a financial advisor.

Quick access to cash

Borrowing against your life insurance policy can be a great option if you need cash quickly. There is no formal approval process for a life insurance loan, and you can simply fill out a form to receive a payment. This is because the value of the plan is technically yours. Additionally, there are typically no minimum income requirements or hard credit checks involved.

No impact on credit score

Unlike bank loans or credit cards, life insurance loans do not affect your credit score. This is because you are borrowing from yourself, and the loan is not recognized as debt.

Flexible repayment schedule

There is no strict repayment schedule for life insurance loans. You can pay back the loan on your own schedule and at your leisure. However, it's important to note that your loan amount shouldn't exceed your cash value, or your coverage may lapse.

Lower interest rates

Life insurance loans typically have lower interest rates than bank loans or credit cards. According to MarketWatch, interest rates on life insurance loans range from 5% to 8%, while the average interest rate for a credit card is 20.40%.

Cons of borrowing against life insurance

Borrowing against your life insurance policy can be a quick and easy way to get cash in hand when you need it. However, there are some disadvantages to consider before making a decision.

Reduced Death Benefit

If you pass away before paying back your loan, the loan balance, plus any interest accrued, will be subtracted from the death benefit that would be given to your beneficiaries. This could be problematic if your beneficiaries need the entire amount of the intended benefit.

Interest Charges

The insurance company will charge you interest on the outstanding balance of your loan. If you fail to make interest payments, your policy could lapse, and the entire loan amount could become taxable.

Risk of Losing Coverage

If the loan balance increases above the amount of the cash value, your policy could lapse and be terminated by the insurance company. You would lose your insurance protection, and your loan would be reclassified as a withdrawal, meaning you would owe income tax on any amount received above what you paid in life insurance premiums.

Tax Consequences

If your policy lapses before the loan is fully repaid, you could owe income tax on the money you haven't paid back. While policy loans are generally not considered taxable income, if your policy lapses, you will be able to recover your policy's "cost basis," which is usually the sum of the premiums paid on a tax-free basis. Any amount received over this cost basis is subject to income tax.

Impact on Guarantees

Permanent insurance guarantees are based on certain assumptions, such as regular premium payments and a certain level of cash accumulation. If you take out a loan, you may deplete the amount required to ensure these guarantees. Some policies will ensure these guarantees even when you take out cash, but at a cost that could force you to pay more in premiums to cover the difference.

Reasons to borrow against life insurance

Borrowing against your life insurance policy can be a convenient way to get quick access to cash. Here are some reasons why someone might choose to borrow against their life insurance:

Quick Access to Cash

Life insurance loans offer a fast way to get cash without the need for a lengthy approval process. There are typically no minimum income requirements or hard credit checks, making it an attractive option for those who need money quickly.

Flexible Repayment Schedule

Life insurance policy loans usually come with flexible repayment schedules. Borrowers can pay back the loan at their leisure and are not tied to a strict repayment schedule. However, it is important to note that the loan amount should not exceed the cash value of the policy to avoid a lapse in coverage.

No Impact on Credit Score

Unlike traditional bank loans or credit card debt, life insurance policy loans do not show up on your credit report. This means that borrowing against your life insurance will not affect your credit score, which can be beneficial for those concerned about maintaining a good credit rating.

Lower Interest Rates

Life insurance loans typically have lower interest rates compared to bank loans or credit cards. According to MarketWatch, interest rates on life insurance loans range from 5% to 8%, which is much lower than the average rate for personal loans and credit cards.

No Risk to Other Assets

When borrowing against your life insurance policy, your policy's cash value is used as collateral. This means that you don't have to put other assets, such as your home or car, at risk. Additionally, the cash value will continue to grow even after you borrow money against it.

How much can you borrow?

The amount of money you can borrow from a life insurance policy depends on the cash value of the policy and the rules set by the insurer. Generally, policyholders can borrow up to 90% of the cash value of their life insurance policy. However, it's important to note that this may vary depending on the insurance company and their specific rules.

The cash value of a life insurance policy is a portion of the policyholder's life insurance payment that is put into a savings-like account. This account grows tax-free over time and can be borrowed against. It is important to remember that the cash value component is typically found in whole life insurance plans and is not an option in term life insurance policies.

When considering borrowing against your life insurance policy, it is crucial to keep in mind the potential risks involved. If you are unable to make timely loan payments, you may lose your life insurance plan. Additionally, if the loan is not repaid before the policyholder's death, the beneficiary will receive a reduced death benefit, as the loan amount and interest owed will be deducted from it.

Before making a decision, it is always recommended to consult with a financial advisor to understand the specific details and implications of borrowing against your life insurance policy.

Which types of life insurance policies can you borrow against?

You can borrow against permanent life insurance policies that have a cash value. This includes whole life insurance and universal life insurance. Term life insurance, on the other hand, does not have a cash value component, so you cannot borrow against it.

Whole life insurance and universal life insurance are more expensive than term life insurance, but they have no predetermined expiration date. If sufficient premiums are paid, the policy remains in force for the lifetime of the insured. While the monthly premiums are higher than term life insurance, the money paid into the policy that exceeds the cost of insurance builds up in a cash value account that is part of the policy. The purpose of the cash value is to offset the rising cost of insurance as you age, allowing premiums to remain level throughout life and preventing them from becoming unaffordable in later years.

The cash value of a whole life insurance policy grows tax-free over time. In a universal life policy, the cash value is invested by the owner in the stock market and grows accordingly.

Frequently asked questions