Life Insurance Loan: Smart Move Or Risky Business?

Borrowing against your life insurance policy can be a quick and easy way to get cash in hand when you need it, but it's important to understand the risks involved. To take out a loan on your life insurance policy, you need to have a policy with a cash value component, which is usually only found in permanent life insurance policies such as whole or universal life insurance. Term life insurance, which is often provided by employers, does not have a cash value and therefore cannot be borrowed against.

One of the main advantages of borrowing against your life insurance policy is the flexibility it offers. There is no credit check or approval process required, and you can use the money for anything you want without having to justify it to anyone. Additionally, there is no strict repayment schedule, and you can pay back the loan at your own pace.

However, there are also several disadvantages to consider. If you don't repay the loan, it will reduce the death benefit that your beneficiaries will receive. Interest will continue to accrue on the loan balance, and if it exceeds the policy's cash value, your coverage could lapse, leaving you without life insurance and potentially facing tax penalties.

Before taking out a loan on your life insurance policy, it's important to weigh the pros and cons carefully and consider the potential impact on your long-term financial goals.

Borrowing from permanent life insurance policies

Borrowing from a permanent life insurance policy is a quick and easy way to get cash when you need it. Unlike a bank loan or credit card, there is no approval process or credit check since you are essentially borrowing from yourself. There is also no requirement to pay the loan back, and you can use the money for anything you like. However, there are some serious caveats to consider before taking out a loan from your life insurance policy.

To borrow from a life insurance policy, you must own a permanent life insurance policy, such as whole or universal life insurance, and have built up a reserve of cash within it. Term life insurance policies, on the other hand, do not have a cash value component and are therefore not eligible for loans.

With a permanent life insurance policy loan, you are essentially borrowing from yourself, with the policy's cash value serving as collateral. The insurance company will charge interest (called a spread) on the loan, which you pay back to yourself, less a small percentage (usually between 0.25% and 2%) kept by the insurance company. Policy loans typically have a much lower interest rate than bank loans and are not considered taxable income. Most companies allow you to borrow up to 90% of your cash value, and you will usually receive the funds within a week.

Advantages

There are several advantages to borrowing from a permanent life insurance policy:

• No credit check or approval process is required.
• You can use the loan funds for anything you choose.
• Loans do not have to be paid back, and there is no set repayment schedule.
• Money from an insurance policy loan is not taxed as income.
• It is a quick and easy way to access cash.

Disadvantages

However, there are also some serious disadvantages and risks associated with borrowing from a life insurance policy:

• The death benefit will be reduced if the loan isn't repaid.
• You will owe interest on the loan, which will continue to accrue until the loan is paid off.
• Failing to repay the loan may result in losing insurance coverage if the loan balance exceeds the cash value of the policy.
• In some cases, you may owe taxes on the amount borrowed if the policy lapses or is terminated.

It is important to carefully consider the pros and cons of borrowing from a permanent life insurance policy before making a decision, as it could impact your future financial security and the benefits received by your beneficiaries.

Pros of life insurance loans

Borrowing from your life insurance policy can be a quick and easy way to get cash. Here are some pros of taking out a loan on your life insurance:

Quick access to cash

Getting a life insurance policy loan is quick and easy. Since you are borrowing against your own assets, there is no approval process, credit check, or income verification. You can usually get a check within a week. This is especially useful if you need quick access to cash.

Low-interest rates

Policy loans generally have a much lower interest rate than bank loans and do not charge high fees or closing costs. Interest rates typically range from 5% to 8%, which is much lower than the average rate for personal loans and credit cards.

Flexible repayment

There is no required monthly payment for a policy loan and no payback date. You can pay it off in a couple of months or let it sit without making any payments for years. However, an unpaid loan accrues interest that is added to your owed balance.

No credit check required

Since you are borrowing your own money, no formal credit check is needed to qualify for a policy loan.

No income tax

Policy loans are not considered taxable income. You can borrow all your cash value, even earnings above what you paid in premiums, without owing income tax.

Cons of life insurance loans

Borrowing from your life insurance policy can be risky and there are several factors to consider before taking out a loan. Here are some cons of life insurance loans:

Reduced Death Benefit

If you don't repay your loan before you die, the loan amount, plus any interest owed, will be deducted from the death benefit paid to your beneficiaries. This could significantly impact the financial security of your loved ones.

Interest Accrual

Life insurance loans accrue interest over time, which can compound and increase the loan balance. If left unpaid, the interest can exceed the cash value of your policy, leading to policy termination and potential tax liabilities.

Risk of Losing Insurance Coverage

Failing to repay the loan may result in your policy lapsing and being terminated by the insurance company. This means you will lose your insurance protection and may owe income tax on the loan amount.

Impact on Policy Value and Performance

Taking out a loan against your policy can erode its value and performance over time. The lower cash value may result in lower earnings, and if your premium payments aren't sufficient to cover the costs, the insurer will take funds from your cash value. This can deplete your cash value and cause the policy to terminate.

Limitations on Borrowing Amount

You can only borrow up to a certain percentage of the cash value of your policy, typically around 90%. If you need to borrow a larger amount, you may need to explore other financing options, which may be more expensive.

Before taking out a life insurance loan, it is important to carefully consider the potential risks and weigh them against your financial needs and circumstances.

How to borrow 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 to know before borrowing. Here is a step-by-step guide on how to borrow from your life insurance policy:

Step 1: Understand the Requirements

Firstly, it's important to note that you can only borrow against a permanent life insurance policy, such as a whole life insurance or universal life insurance policy. These policies have a cash value component that builds over time, allowing for policy loans. On the other hand, term life insurance policies, which provide coverage for a limited period, typically do not have a cash value and therefore cannot be borrowed against.

Step 2: Ensure You Have Sufficient Cash Value

Before taking out a loan, make sure that your permanent life insurance policy has accumulated enough cash value. It usually takes a few years for the cash value to build up to a level where you can borrow against it. Each insurance company will have different rules, but generally, you can borrow up to around 90% of the policy's current cash value.

Step 3: Understand the Risks and Consequences

Borrowing against your life insurance policy is not without risks. It's important to understand the potential consequences before proceeding. If you don't repay the loan, the death benefit for your beneficiaries will be reduced by the amount owed, including any accrued interest. Additionally, if the loan amount plus interest exceeds the policy's cash value, your policy could lapse or be cancelled, resulting in a loss of insurance coverage.

Step 4: Contact Your Insurance Company

Once you have confirmed that your policy meets the requirements and you understand the risks, contact your insurance company or agent to initiate the loan process. They will be able to provide you with specific information about your policy and guide you through the necessary steps.

Step 5: Submit a Loan Application

You will need to submit a policy loan application with your insurance provider. The application process is typically simpler than a traditional bank loan, and many providers allow you to apply online. After submitting your application, the processing time can vary from two weeks to a month, depending on the provider.

Step 6: Receive the Funds

Once your application is approved, the funds will usually be sent to your bank account within a week. You can then use the money as needed, without any restrictions on how you spend it.

Remember, while borrowing from your life insurance policy can provide quick access to cash, it's important to carefully consider the pros and cons before making a decision. Be sure to understand the potential risks and how they could impact your policy and your beneficiaries.

Interest rates on life insurance loans

Life insurance loans usually have variable or fixed interest rates, which depend on the type of policy. For example, in a regular universal life policy, the cash value grows based on current interest rates, while in a variable universal life policy, the cash value is invested in the stock market and grows accordingly.

It's important to note that interest accrues on life insurance loans, and if left unpaid, it can reduce the death benefit or even cause the policy to lapse. Therefore, it is advisable to set a personal repayment schedule to ensure the loan is repaid without accruing significant interest.

Frequently asked questions