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A life insurance policy is a great way to get cash when you need it. You can borrow against the cash value of your policy and use the money for any purpose. There are no loan requirements or qualifications, and you can pay the loan back whenever you want.
Life insurance policy loans have relatively low-interest rates, making them a great option when you need extra cash.
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Assuming you can keep up with your payments, taking out a loan against your life insurance policy is an easy way to access cash. However, defaulting on paying back this loan and the interest could result in a reduction of the death benefit if you were to die with an outstanding loan balance.
In some cases, you could even end up losing your life insurance coverage.
What type of Life Insurance Can I borrow Money From?
First and foremost, you cannot borrow money from a term or accidental death life insurance policy since these types of policies do not have a cash value component that builds over time. All premium dollars are applied to the cost of life insurance and any fees charged by the insurer.
Permanent life insurance is the only type of life insurance that builds cash value and provides an option to borrow against the cash value.
It’s important to understand that the money you borrow comes from the insurance company and not your policy’s cash value. However, your cash value account is collateralized to the extent of the loan.
Moreover, your collateralized cash value will continue to earn interest and dividends (if the policy is a participating policy), and therefore, your cash value account will continue to grow. The types of insurance policies you can borrow against are policies that have a cash value account such as Whole Life Insurance, Variable Life Insurance, and Universal Life Insurance.
How Much Money Can I Borrow against my Policy?
When there is enough cash value, life insurance policies can be used to take out a loan. The amount that can be borrowed is calculated as a percentage of the cash value. Most life insurance companies have rules in place dictating how much policyholders can borrow, but generally speaking, you can expect to be able to borrow between 90% and 95% of the cash value.
A typical example would be if your whole life policy has accumulated $25,000 over time, the insurance would typically lend between $22,500 and $23,750. Generally, the insurer will charge a small fee for making the loan and will also charge interest for the life of the loan.
The insurer will also attempt to make certain that your policy does not lapse as a result of the loan.
Additionally, the loan proceeds to you are tax-exempt because the money you’ve borrowed from the insurance company is not considered income.
Is there a Time Limit on Paying Back my Life Insurance Loan?
When you take out a loan on your life insurance, there is no repayment schedule that you must adhere to, thus there are no late payment fees. In fact, you do not have to pay back the loan at all because the insurance company will simply deduct any outstanding loan and interest from the death benefit when you die.
However, when taking out a loan, it is important to be aware of the effects of compounding interest. This is especially true for loans that span over many years. With compounding interest, the total amount of the loan can quickly become much larger than the original sum borrowed.
Furthermore, loans that reach the size of the policy’s cash value can cause the policy to lapse. This would not only mean losing coverage but also having to pay a large tax bill.
How Should I pay back My Life Insurance Loan?
Life insurance policy loans don’t have a specified repayment period, which means you can take as long as you want to repay the loan. However, interest accumulates on the loan over time, so it’s best to repay the loan in a timely manner to avoid any negative consequences.
Most insurance professionals recommend setting up a personal schedule for repaying your loan that fits within your budget. Generally, the insurance company will provide a method to make payments outside of your normal insurance premium.
If you have more than one outstanding loan, we recommend that you keep track of each one and make your payments accordingly. Your insurance company will send you an annual statement for your account that will illustrate outstanding loans, amounts repaid, and interest that has been charged for the loan.
What are the Pros and Cons of Borrowing Money from a Life Insurance Policy?
If you are considering borrowing money from your permanent life insurance policy, you should consider these pros and cons and also have a frank discussion with your insurance professional.
Advantages
- Borrow for any reason: You do not have to have a particular reason to borrow money against your policy. You can use the funds you borrow as you see fit.
- A credit check is not required: Since your loan is from the life insurance company and is 100% collateralized with the funds in your cash value account, you’ll not be subject to any credit check to qualify for your loan.
- Competitive interest rates: Your insurance policy loan is considered a lower-interest financing option. Since the rates are generally between 5% and 8% they are competitive with typical lenders and you never have to jump through the hoops of a typical underwriting process.
- You set the repayment schedule: Since there is no formal repayment schedule, you can pay back the loan when it’s convenient for you or not pay it back at all.
- No Impact on your cash value account: Although your cash value account is collateralized to cover your loan, the account continues to earn interest and dividends which can easily offset the interest you’ll pay.
Disadvantages
- Minimum cash value requirement needed: You need to have enough money in your cash account before you can borrow against it. This can take considerable time if you’re making only minimum payments. Your policy’s illustration will provide an accurate indication of when you can start dipping into your cash value account.
- Limited Loan Amount: Your insurance company will limit the amount you borrow to about 90% of your cash value at the time of the loan.
- Impact on the death benefit: Since your loan is collateralized by your cash value account, if you die with an outstanding loan balance, that amount will be deducted from your beneficiary’s death benefit.
- The risk of a policy lapsing: Although you are not required to repay your loan according to a set schedule, interest will continue to accrue and the insurer will still charge for policy expenses. Failure to repay the loan may cause the policy to lapse, requiring you to pay premiums in order to keep it in force.
Frequently Asked Questions
If you are considering taking a loan out on your life insurance policy, by all means, CALL YOUR INSURANCE COMPANY.
If you are considering purchasing life insurance and you want to be able to access the cash value through policy loans, call the experts at LifeInsure.com for expert advice and a free no-obligation quote.
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