Borrowing Cash Value: Life Insurance As Collateral

Borrowing against the cash value of your life insurance policy can be a quick and easy way to get cash in hand when you need it. However, it's important to understand the risks and mechanics of doing so. In this article, we will explore how to borrow against your life insurance policy, the pros and cons of doing so, and some alternative options.

Borrowing against permanent life insurance

Here's what you need to know about borrowing against permanent life insurance:

When you borrow against your permanent life insurance policy, you are taking out a loan from the insurance company, using the cash value of your policy as collateral. The loan is not taken out from the policy itself, but the cash value continues to accumulate, and you are charged interest on the loan amount. The interest rate is typically lower than that of a personal loan or credit card, and there is no set repayment period. However, if you don't repay the loan, the interest will compound over time, reducing your death benefit and possibly causing your policy to lapse.

Advantages

Borrowing against your permanent life insurance policy offers several advantages:

• Easy loan qualification: There are no specific income or credit score requirements, and there is no approval process or credit check.
• Competitive interest rates: Interest rates are usually lower than those for personal loans or credit cards.
• Flexible repayment: There is no set repayment schedule, and you can pay back the loan at your own pace.
• No other collateral required: Your policy's cash value serves as collateral, so you don't need to put up any other assets.
• Loans for any purpose: You can use the loan for anything you need, without having to justify your spending.

Disadvantages

However, there are also some disadvantages to consider:

• Reduction of death benefit: If you don't repay the loan, your death benefit will be reduced by the loan amount and any accrued interest.
• Potential for policy lapses and cancellation: If the loan amount and interest exceed the policy's cash value, your coverage could lapse or be cancelled.
• Potential tax implications: If your coverage lapses, you may owe taxes on the interest or investment gains of the policy's cash value.

How to Borrow

To borrow against your permanent life insurance policy, simply reach out to your agent or insurance company and fill out a basic form. If your cash value is sufficient, the funds will typically be deposited into your account within a few days. Remember that the loan isn't free money, and there can be long-term effects on your coverage and benefits, so consider your options carefully before taking out the loan.

Pros and cons of borrowing against life insurance

Borrowing against your life insurance policy can be a quick and easy way to get cash. However, there are several pros and cons to consider before making a decision.

Pros

• Easy loan qualification: You won't need to meet specific income or credit score requirements as you would with a traditional loan.
• Competitive interest rates: The interest rates on life insurance loans are typically lower than for a personal loan and significantly lower than credit card rates.
• Loans for any purpose: You can use life insurance loans for anything, unlike many loans that are tied to a specific purpose.
• No other collateral requirements: Your policy's cash value is collateral for your loan, so you won't have to put up any other assets.
• Policies can still earn interest and dividends: Even with a loan against your policy, the cash value may continue to earn dividends or interest.
• Flexible repayment: Life insurance loans can be paid back over time and don't have a fixed repayment schedule. In fact, most life insurance loans don't have to be paid back at all—the outstanding value of the loan and interest are simply deducted from the death benefit.

Cons

• Not all policies will qualify: Term life and other policies that don't build cash value can't be used for loans.
• Can be slow to fund: In some cases, it can take a month or more to receive funds from life insurance loans.
• Reduction of death benefit: If you don't repay the loan, the value of your death benefit will be reduced by the loan amount and any accrued interest.
• Potential for policy lapses and cancellation: If the loan amount plus interest accrued grows to be more than the policy's current cash value, your coverage could lapse or even be canceled.
• Potential tax implications: If your coverage does lapse, you may end up owing taxes on the interest or investment gains of your policy's cash value.

Interest rates and repayments

Interest rates on a life insurance loan typically range from 5% to 8%, which is much lower than the average rate for personal loans and credit cards. The interest rate on your loan will depend on the type of policy you have. For example, in a regular universal life policy, it grows based on current interest rates, while in a variable universal life policy, the cash value is invested by the owner in the stock market (and grows accordingly).

Unlike a traditional loan, there is no formal repayment timeline for a life insurance loan. However, it is in your best interest to pay back the loan as soon as possible, as the longer your loan is left unpaid, the more interest you will end up owing. Additionally, if you don't make regular payments, your policy will be at risk of lapsing, especially if the amount owed exceeds the policy's cash value.

If you die with an outstanding life insurance loan, your insurer will deduct the amount owed, including any interest, from your death benefit, leaving your beneficiaries with less money. Therefore, it is important to consider the potential impact on your beneficiaries when deciding whether to take out a loan against your life insurance policy.

While life insurance loans are generally tax-free, you may owe taxes on the amount borrowed if you don't repay the loan or if your policy lapses. It is recommended to speak with a financial advisor to understand the tax implications before borrowing from your life insurance policy.

How to get a life insurance loan

Borrowing against your life insurance policy can be a quick and easy way to get cash in hand when you need it. Here is a step-by-step guide on how to get a life insurance loan:

Step 1: Check Your Policy Type and Cash Value

Firstly, you need to check if your life insurance policy allows for loans. Generally, only permanent life insurance policies, such as whole life insurance or universal life insurance, allow for loans. These policies have a cash value component that builds over time and can be used as collateral for a loan. Term life insurance policies, on the other hand, are typically cheaper and do not have a cash value component, so you cannot borrow against them.

Once you've confirmed that your policy type allows for loans, you need to check the cash value of your policy. The cash value is the amount of money you would receive if you were to surrender the policy. This value grows over time, and you can usually only borrow against your policy once this value has reached a certain minimum threshold, which can take several years.

Step 2: Understand the Risks and Requirements

Before taking out a life insurance loan, it's important to understand the risks and requirements involved. The main requirement is that you have sufficient cash value in your policy to borrow against, and the minimum amount can vary depending on the insurer. Additionally, borrowing against your life insurance policy is not risk-free. If you die with an outstanding loan on your policy, your insurer will deduct the amount owed from your death benefit, leaving your beneficiaries with less money. Furthermore, if you don't make regular payments, your policy could lapse, especially if the amount owed exceeds the policy's cash value.

Step 3: Contact Your Insurance Company

If you have confirmed that your policy type allows for loans and you have sufficient cash value, you can then contact your insurance company to initiate the loan process. There is usually no approval process or credit check required, and you can request a loan for any reason. The application process is typically much simpler than a traditional bank loan, and many providers allow you to apply online.

Step 4: Understand the Repayment Terms

Life insurance loans typically have flexible repayment terms, and there is no strict repayment schedule. However, it is in your best interest to pay back the loan as soon as possible to avoid accruing excessive interest. Additionally, if you don't make regular payments, your policy could lapse, especially if the amount owed exceeds the policy's cash value. It's important to note that even if you don't repay the loan during your lifetime, the amount owed will be deducted from your death benefit.

Step 5: Receive the Funds

Once your loan application has been approved, the funds will typically be sent to your bank account within a week. You can then use the money as needed, as there are usually no restrictions on how you can spend the loan.

Reasons to borrow 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 reasons why you might consider doing so:

Easy loan qualification:

Unlike traditional loans, you won't need to meet specific income or credit score requirements to qualify for a life insurance loan. There is also no approval process, credit check, or employment verification.

Competitive interest rates:

The interest rates on life insurance loans are typically lower than those for personal loans and significantly lower than credit card rates. According to MarketWatch, interest rates on life insurance loans range from 5% to 8%.

Loans for any purpose:

You can use life insurance loans for anything, unlike many loans that are tied to a specific purpose such as the purchase of a vehicle or property. There are no restrictions on how you can spend the money.

No other collateral requirements:

Your policy's cash value is used as collateral for the loan, so you won't have to put up any other assets, such as your home or vehicle, to secure the loan.

Flexible repayment:

Life insurance loans can be paid back over time in a flexible manner, unlike the fixed repayment schedules of traditional loans. In fact, most life insurance loans don't have to be paid back at all—the outstanding value of the loan and interest are simply deducted from the death benefit. However, it is in your best interest to pay back the loan as soon as you can to avoid accruing more interest.

Policies can still earn interest and dividends:

Even if you take out a loan against your policy, the cash value may continue to earn dividends or interest, though at a lower rate than on non-borrowed funds.

However, it's important to remember that borrowing against your life insurance policy is not without risks. If you don't repay the loan, your death benefit will be reduced, and you may even lose your policy if the loan amount plus interest exceeds the policy's cash value.

Frequently asked questions