Alyssa Lane
Life insurance loans can be a quick and easy way to get cash in hand when you need it. However, there are a few specifics to know before borrowing. Firstly, you can only borrow against a permanent life insurance policy, such as a whole life insurance or universal life insurance policy, which has a cash value component. Term life insurance, on the other hand, does not have a cash value and is thus not eligible for borrowing.
The loan process is straightforward, as there is no credit check or approval process required. The only requirement is that you have sufficient cash value built up in your policy, which can take several years. The interest rates on life insurance loans are typically lower than those for personal loans, ranging from 5% to 8%.
While life insurance loans offer flexible repayment terms, it is important to manage the loan balance to avoid negative consequences. If the loan is not repaid, it will reduce the death benefit that your beneficiaries will receive. Additionally, if the loan and interest grow too large, they could exceed the cash value and cause the policy to lapse, resulting in a potential income tax liability.
| Characteristics | Values |
|---|---|
| Type of insurance | Permanent life insurance, including whole life insurance, universal life insurance, variable life insurance, and indexed universal life insurance |
| Borrowing requirements | Sufficient cash value in the policy |
| Borrowing limit | Up to 90% of the policy's cash value |
| Interest rates | Generally lower than personal loans and credit cards, ranging from 5% to 8% |
| Repayment schedule | Flexible, but regular payments are recommended to avoid accruing significant interest |
| Impact on death benefit | If the loan is not repaid, the death benefit will be reduced by the outstanding amount and any accrued interest |
| Tax implications | Generally tax-free, but may be taxed as income if the policy lapses or is surrendered before full repayment |
| Credit check required | No |
What You'll Learn
Borrowing from permanent life insurance
Permanent life insurance, which includes whole life insurance and universal life insurance, is more expensive than term life insurance but has no predetermined expiration date. If sufficient premiums are paid, the policy will remain 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 a cash value that is part of the policy. This cash value can be borrowed against.
The cash value of a permanent life insurance policy is an asset that you can borrow against, and life insurance policy loans are typically easier to get than a bank loan. Plus, you don't have to tell the lender what you want to do with the money. The application process is relatively easy, and there is no income or credit check. Approval is essentially automatic, and the loan interest rate is typically lower than a personal loan or even a home equity loan. The money may be deposited into your account within a few days.
Each life insurance company sets its own rules about how much money can be borrowed from a policy, but you can typically borrow up to 90% of the value in your policy. And, unlike most loans, there is no set repayment period. However, if you pass away before the loan is repaid, any outstanding loan balance will be deducted from the death benefit.
Loan funds don't actually come out of your policy but are lent by the insurance company, which uses your policy as collateral. Since the money stays in your policy, it continues to earn interest and grow tax-favoured. However, you are charged interest on your policy loan, which, if unpaid, will be added to your loan amount.
If you don't repay the loan, the interest will compound over time and be added to your loan balance, further lowering your death benefit. And if the total loan balance grows larger than your cash value, the policy could lapse. When your policy lapses, the cash you took out may be treated as income, and you could owe taxes on it.
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No credit check required
Life insurance companies are increasingly using credit checks as part of the application process. However, this is not a hard credit check and will not impact your credit score. A credit check can speed up the application process and make it easier and cheaper to get life insurance, especially if you have good credit.
However, if you are borrowing against your life insurance policy, no credit check is required. This is because you are borrowing from yourself, and your cash value is used as collateral. This can be a quick and easy way to get cash, and there is no approval process or credit check.
There are several advantages to borrowing against your life insurance policy. Firstly, there are no additional requirements, such as a credit check, employment verification, or minimum income requirements, so you can get money quickly when you need it. Secondly, your cash value will continue to grow after you borrow money against it, and you can pay back the loan when you want without being tied to a repayment schedule. Finally, there are no restrictions on how you can spend the money.
However, it is important to note that if you do not repay the loan, the death benefit will be lower, and your policy may lapse. Additionally, the interest on the loan will continue to accrue, and if it exceeds the policy's cash value, you may owe taxes on the amount borrowed.
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Pros and cons of life insurance loans
Pros of a Life Insurance Policy Loan
Life insurance policy loans can be a quick and easy way to obtain cash. There is no lengthy approval process, credit check, or income verification. You can borrow up to 90% of your cash value and the funds can be used for anything you choose. There is also no required monthly payment or payback date, and the funds are generally tax-free.
Cons of a Life Insurance Policy Loan
If the loan is not repaid before death, the death benefit will be reduced as the loan balance and interest will be subtracted from it. Interest will continue to accrue on the loan, and if the balance exceeds the policy's cash value, the policy could lapse and be terminated by the insurance company. In this case, you may also owe income tax on the amount borrowed.
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Interest rates
The interest rate on a life insurance loan is determined by the insurance company and is usually based on current market interest rates. Some policies may offer a fixed interest rate, while others may have a variable rate that changes over time. It's important to review the terms and conditions of your life insurance policy to understand the specific details of a potential loan, including the interest rate.
The interest rate on a life insurance loan can vary depending on several factors, including the insurance company, the type of policy, and the current market interest rates. It's always a good idea to compare interest rates from multiple insurance companies before taking out a loan to ensure you're getting a competitive rate.
It's worth noting that while life insurance loans offer lower interest rates, they also come with certain risks. If the loan is not repaid, the interest will continue to accrue, reducing the death benefit for your beneficiaries. Additionally, if the loan amount and interest exceed the cash value of the policy, it could result in a policy lapse, leaving you without insurance coverage. Therefore, it's crucial to consider the potential risks and ensure timely repayment to avoid these consequences.
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Repaying the loan
Repaying a loan taken out against your life insurance policy is important to avoid negative consequences, such as a reduced death benefit, the risk of policy lapse, and significant interest accumulation. Here are some key points and tips for repaying your life insurance loan:
- Understand the loan terms: Make sure you fully understand the terms and conditions of your life insurance loan, including the interest rate, repayment options, and any penalties for non-payment.
- Make timely payments: Even though life insurance loans typically don't have a strict repayment schedule, it's in your best interest to repay the loan as soon as possible. The longer the loan remains unpaid, the more interest will accrue.
- Keep up with premium and interest payments: Regularly pay your premiums and interest to avoid a policy lapse. If the loan and interest exceed the death benefit amount, your policy could lapse, leaving you without coverage.
- Set up automatic payments: Consider setting up automatic payments through your checking account to ensure you don't miss any important payments.
- Stay below the cash value limit: Ensure that the principal plus interest does not exceed the cash value of your policy. If it does, your insurance coverage may be at risk of lapsing.
- Make interest payments: If the loan balance is close to or exceeds the cash value, focus on making at least the minimum interest payments to avoid a policy lapse.
- Inform your beneficiaries: Discuss your decision to take out a loan with your beneficiaries so they are aware of the potential impact on their death benefit.
- Consider full repayment: While not always required, fully repaying the loan will ensure that your death benefit remains intact and your beneficiaries receive the full payout.
- Consult a financial advisor: If you're unsure about the best repayment strategy, consider seeking advice from a financial professional. They can help you understand the tax implications and potential risks associated with different repayment options.
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Frequently asked questions
You can borrow from permanent life insurance policies that build cash value. These include whole life and universal life (UL) policies. Term life insurance policies do not have a cash value component, so you cannot borrow against them.
A life insurance loan allows you to borrow money from the insurance company, using your policy's death benefit and cash value as collateral. There is usually no approval process or credit check, and you can use the money for any reason. The loan is tax-free as long as the policy stays active, but interest will be charged.
The amount you can borrow depends on the cash value of your policy and the limit set by your insurer. You can typically borrow up to 90% of the policy's cash value, but this may vary by insurer.
Life insurance loans do not have a strict repayment schedule, but it is in your best interest to pay them back as soon as possible to minimise interest. If the loan is not repaid before your death, the outstanding balance and interest will be deducted from the death benefit paid to your beneficiaries.
A life insurance loan can provide quick access to cash without a credit check and typically has lower interest rates than other types of loans. However, if the loan is not repaid, it will reduce the death benefit and could cause the policy to lapse if the loan and interest exceed the cash value.
