Borrowing Against Your Life Insurance Policy: Should You Take Out a Loan?
Borrowing against the cash value of a permanent life insurance policy is simple. There are no loan requirements or qualifications (other than the amount of cash value), and the funds can be used for whatever purpose you choose and repaid whenever you want, plus a life insurance policy loan has relatively low interest rates. What's the catch? If you fail to pay the interest on the loan, you may lose your policy (and its cash value) and face a large tax bill. Borrowing against your life insurance policy is a simple way to get cash if you can keep up with your payments.
Can you borrow against your life insurance policy?
A life insurance policy's cash value is the amount of money you would receive if you surrendered the policy. When you pay premiums for a cash value life insurance policy, such as whole or universal life insurance, a portion of the premium is applied to the cash value.
The cash value grows over time at an interest rate determined by the terms of the policy. If you have a cash-value permanent life insurance policy, you can borrow money from the insurer and use the cash value as collateral. However, this option is typically only available once the cash value of your life insurance policy has reached a certain size, which may take five to ten years of paying premiums.
Because term life insurance policies do not have a cash value component, they are less expensive than permanent policies. You cannot borrow against them, and if you choose to surrender a term life insurance policy, you will not be compensated.
How Much Can You Borrow from a Life Insurance Policy?
The amount you can borrow from a life insurance policy varies depending on the insurer, but the maximum policy loan amount is typically at least 90% of the cash value, with no minimum.
When you take out a policy loan, you are not deducting money from your account's cash value. Instead, you obtain a loan from the insurer and use the cash value as collateral. This is a significant advantage because the cash value remains in the life insurance policy and earns interest.
You are not required to repay the loan within a specific time frame, as is the case with many other types of loans. If you do not pay the annual interest, which can be fixed or variable, the interest payment will be added to the value of your outstanding loan.
Length of the loan
Compounding interest will be charged if your loan is for a long period of time. And if the total outstanding loan exceeds the cash value of your policy, the policy will lapse. If this occurs, you will lose your coverage and face a large tax bill if the outstanding loan exceeds the amount you have paid in premiums.
Borrowing nearly the entire cash value of the policy carries risk, so if you take out a policy loan, keep a close eye on its size in relation to your cash value. Furthermore, we would advise making interest payments whenever possible.
How do you take out a life insurance policy loan?
The procedure for obtaining a life insurance loan is simple. You simply fill out a form from the insurer, and the money is usually deposited into your account within a few days. Before receiving your loan, you may be required to confirm your identity, sign a confirmation document, or provide a notarized confirmation if:
- In the last month, you provided the insurer with new account information.
- Recently, the policy's ownership changed.
- The loan is larger than a certain amount, such as $50,000.
Pros and cons of taking out a life insurance loan
Life insurance collateral loans are an easy way to get money quickly and with few restrictions. You must exercise extreme caution when managing the account's cash value and paying off interest as needed.
Aside from the risk of the policy lapse, there are few drawbacks to borrowing against your whole life insurance or universal life insurance policy.
There are no qualifiers for a policy loan
Unlike other loans, borrowing against your life insurance policy does not require you to qualify. Because there is no credit check, the loan will not appear on your credit report. Furthermore, you are not required to provide proof of income. You'll only need to prove your identity and that you're requesting the loan at most.
Life insurance collateral loans can be a great solution if you need money quickly, such as for an emergency medical expense, because there are no checks or qualifications. They can also be used as a stopgap if you're applying for a loan elsewhere and it's taking a long time to be approved.
Policy loans have low-interest rates
Interest rates on life insurance collateral loans are typically lower than those on a personal loan or credit card. While rates vary, they typically fall between 6% and 8%, depending on who holds your insurance and what policy you have. For example, we obtained loan interest rates for variable universal life insurance policies from three of the largest insurers:
Insurer | Product | Policy Loan Annual Interest Rate |
Northwestern Mutual | Custom Variable Universal Life Insurance | 5%, plus up to 2% additional debt expense charge |
New York Life | Variable Universal Life Accumulator | 6% maximum, currently 3% |
Prudential | Variable Universal Life Protector | 2% if the policy has been in place less than 10 years, else 1.05% |
Throughout the loan, your cash value earns interest. This could be at a fixed rate (say, 1.5 percent) or within a certain spread of the loan interest rate. For example, if your cash value was guaranteed to grow at a rate within 2% of your loan interest rate, which was 6%, it would have to be at least 4%.
Pay it back anytime
When you borrow from your life insurance policy, you are not required to repay the loan. Furthermore, you are not required to pay the annual interest as long as the total outstanding loan (original loan plus accumulated interest) does not exceed the cash value of the policy. Borrowing from your life insurance policy is thus an excellent option if you are unsure how long you will require the loan.
Now, it's usually in your best interest to repay a policy loan as soon as possible. The loan's interest compounded annually, and the policy will lapse if the outstanding loan becomes too large. If this occurs, you will have spent thousands of dollars on premiums and will have nothing to show for it (no coverage). Furthermore, if the outstanding loan balance exceeds the premiums paid, you may owe taxes.
Another reason to repay the policy loan is that the total outstanding balance will be deducted from the death benefit payable to your beneficiaries if you die.