Whole Life Insurance Loan: Borrowing Against Your Policy

Whole life insurance is a type of permanent life insurance that provides coverage for your entire life, rather than for a limited period. It is characterised by level premiums and a savings component, allowing you to build cash value over time. This cash value can be borrowed against to meet immediate financial needs. However, it's important to understand the risks involved, as borrowing against your life insurance policy may reduce your death benefit and increase premiums due to interest.

Borrowing against whole life insurance

Whole life insurance is permanent life insurance that combines life insurance with an investment component. It pays a benefit upon the death of the insured and is characterised by level premiums and a savings component. The savings component allows the policy to build cash value over time, which can be borrowed against.

Whole life insurance policies have two values: the face value or death benefit, and the cash value. The death benefit amount increases over time, and the cash value can be borrowed against once it reaches a certain amount. The specific amount required varies by insurer. The loan is provided by the insurance company, and the policy is used as collateral.

Borrowing against a whole life insurance policy can be a quick and convenient way to access cash. There is usually no credit check, interest rates are typically low, and there is no timetable for when the loan must be repaid.

There may be little to no cash value built up to borrow against initially. If the loan is not repaid during the borrower's lifetime, the death benefit will be reduced. There is also a risk of losing coverage if interest accrues and the loan amount plus interest exceeds the policy's cash value. In this case, the policy may lapse, and there may be potential tax consequences.

Borrowing from a whole life insurance policy is a simple process. The policyholder contacts their insurance agent or company and fills out a basic form. If the cash value of the policy is sufficient, the funds are usually provided within a few business days.

The amount that can be borrowed depends on the cash value of the policy. Most insurers allow policyholders to borrow up to 90% of the policy's cash value, but this limit can vary. It's important to note that if the loan amount plus interest exceeds the policy's cash value, the policy may lapse.

Pros and cons of whole life insurance loans

Whole life insurance is a type of permanent life insurance that offers lifelong coverage. This means that it will pay out to your loved ones no matter when you pass away. It is designed to last your entire life and will never expire as long as you continue to pay the premiums, which will remain the same. In addition to a guaranteed death benefit for your beneficiaries, it can help you build cash value, which accrues interest over time. You may tap into the cash value while you're still alive through a withdrawal, loan, or by surrendering the policy.

Pros

• Quick access to funds: Borrowing against your life insurance policy gives you quick access to funds with no approval process.
• No impact on credit score: Borrowing against your life insurance policy won't affect your credit score as there is no credit check involved.
• Flexible repayment terms: Life insurance loans don't have a fixed repayment schedule, and you can pay back the loan at your convenience.
• Lower interest rates: Interest rates for life insurance loans are generally lower than those for personal loans and credit cards, typically ranging from 5% to 8%.
• No usage restrictions: There are no restrictions on how you can use the money borrowed against your life insurance policy.

Cons

• Reduced final payout: If you don't repay the loan with interest before your death, your beneficiaries will receive a reduced death benefit.
• Policy lapse: If the outstanding loan balance and interest exceed the cash value of your policy, it may lapse, leaving you without coverage.
• Potential tax liability: If your policy lapses and the loan balance exceeds the cost basis, you may face income tax liability on the borrowed amount.
• No set payment terms: Life insurance loans don't have set payment terms, which can make it challenging to keep track of repayments and may result in accrued interest over time.

Eligibility requirements for whole life insurance loans

• Policy ownership and duration: To borrow against a whole life insurance policy, you typically need to be the policy owner and have held the policy for a minimum period, often at least ten years. This duration requirement allows the policy to build sufficient cash value, which serves as collateral for the loan.
• Minimum cash value: Insurers usually set a minimum cash value that must be accrued in the policy before you can borrow against it. This minimum value varies by insurer, and it may take several years for the policy to reach this threshold.
• Percentage of cash value: The amount you can borrow is typically limited to a certain percentage of the policy's cash value, usually up to 90%. The exact percentage varies by insurer and policy.
• Premium payments: To maintain eligibility for a loan, you must keep your policy active by making regular premium payments. Failing to pay premiums can lead to a lapse in coverage and affect your ability to borrow.
• Health and medical history: Insurance providers assess applicants' health to determine their eligibility. This includes evaluating any pre-existing medical conditions, previous surgeries, ongoing treatments, and habits that can impact long-term health, such as smoking. A medical examination may be required depending on the insurer's guidelines.
• Financial stability: Insurers may evaluate your financial stability to ensure you can afford the premiums and maintain the policy. They may consider factors such as income, debt-to-income ratio, and smoking status, which can impact premium rates.
• Age requirements: The minimum age to apply for whole life insurance is typically 18, while the maximum age for eligibility can vary but is often between 65 and 75. Some insurers offer policies with no maximum age limit.

It is important to carefully review the eligibility requirements and loan provisions of your specific whole life insurance policy. Consulting a financial advisor can help you understand the risks and benefits of borrowing against your life insurance policy and make an informed decision.

Interest rates and fees

Whole life insurance loans typically have interest rates ranging from 5% to 8%, which is significantly lower than the average rate for personal loans and credit cards. The interest rate on a whole life insurance loan is similar to the interest rate on a bank loan or credit union loan, but without the lengthy approval process. The interest rate will be fixed or variable, depending on the policy.

Since there is no approval process for whole life insurance loans, there are also no associated fees. There are no credit checks, employment verification, or minimum income requirements, making it a quick and easy way to access funds. The only requirement is that the policy has sufficient cash value to borrow against, and the minimum amount varies by insurer.

While there are no set repayment terms, it is in the borrower's best interest to repay the loan as soon as possible. The longer the loan is left unpaid, the more interest will accrue. If the loan balance exceeds the remaining cash value of the policy, it may lapse, and the borrower will lose their coverage. Additionally, if the borrower dies with an outstanding loan on their policy, the insurer will deduct the amount owed, including any accrued interest, from the death benefit paid to the beneficiaries.

Repayment options

Life insurance loans don't have a fixed repayment schedule like traditional loans. However, it is in your best interest to pay back the loan as soon as possible. The longer the loan is left unpaid, the more interest you will end up owing. If you don't make regular payments, your policy will be in jeopardy of lapsing, especially if the amount owed exceeds the cash value of your policy.

If you repay all or a portion of the loan, you have the following options:

• Periodic payments of principal with annual payments of interest
• Paying annual interest only
• Deducting interest from the cash value

The interest rate on a life insurance loan is typically fixed or variable, depending on your policy, and usually falls in the range of 5% to 8%.

If you don't repay the loan before your death, the insurance company will reduce the death benefit by the amount owed, leaving your beneficiaries with less money. The accumulated interest can also reduce the benefit. Therefore, it is important to make a plan to pay back the loan to avoid decreasing the value of your policy.

Frequently asked questions