Can You Borrow Against Life Insurance?
Yes, you can borrow against a life insurance policy, but only if your policy meets specific conditions. Generally, to meet those conditions, you must hold a permanent life insurance policy that has a cash value. Outside of holding a cash value life insurance policy, the conditions in which you can borrow against it vary by policy and insurer. Keep in mind that regardless of the conditions of your policy, it’s critical to repay your debt in a timely manner.
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Understanding How Borrowing Against Life Insurance Works
You can usually take out a life insurance policy loan of up to 90% of your policy’s cash value as long as the cash value meets a minimum threshold set by your insurer. However, there are a couple of pieces of information to remember should you borrow from your life insurance policy.
- Once you’ve borrowed against your life insurance policy, repayment is your responsibility. Policy loans rarely provide a set repayment schedule, so it’s up to you to make prompt payments. Ensure you have all the information you need to repay your loan and set up automatic payments if possible.
- Ensure you keep track of your loan’s interest to keep your policy from lapsing. Interest rates on policy loans vary but are usually lower than those on credit cards and personal loans, often ranging from 5% to 8%.
- With this type of loan, you do not have to undergo a credit check (or take a resulting hit to your credit score) since your policy’s cash value acts as collateral. This means if you pass away before repaying your policy loan, your total owed amount—plus interest—will be deducted from your policy’s death benefit.
How to Borrow Money From Your Policy
Follow these steps to receive a loan from your life insurance policy.
1. Confirm Your Policy Type
You can only borrow against permanent life insurance policies, such as whole life insurance and universal life insurance, which guarantee coverage throughout your life. You cannot borrow against term life policies, which provide coverage for only a limited period, after which they expire. One caveat to that rule is that most term policies are convertible to permanent policies. If you convert your term policy to a permanent one, you may be able to borrow against it.
2. Find Out What Your Policy is Worth
The best way to determine your policy’s cash value is to contact your insurer and ask. Generally speaking, policies with higher premiums tend to have a larger cash value. This amount is highly variable because, although most permanent life insurance policies have a cash value component, they may accumulate that amount in different ways.
For instance, some permanent life insurance policies include an investment feature or an invested portion of the policy that earns interest. This investment feature is referred to as a policy’s cash value, and it grows over time as the invested portion builds interest.
3. Discuss the Terms With Your Insurer
As with the method in which permanent policies accumulate value, so do the loan terms. The terms are a set of rules and regulations that are determined based on your policy and financial situation. These terms include:
- Interest rate
- Repayment schedule
- Minimum and maximum loan amounts
- The impact of the loan on the policy’s death benefit
- Any other associated fees or charges
For example, most insurers require that your policy reaches a minimum cash value before you can borrow against it. However, standards vary among providers, so ask your agent about the minimum cash value required for borrowing against your life insurancde policy. The total amount of the loan is also highly variable. In many cases, you cannot borrow more than 90% to 95% of your life insurance policy’s cash value.
4. Borrow From Your Policy
Once you’ve confirmed the terms of taking out a life insurance policy loan, it’s time to formally request the loan. Many insurers allow you to complete this step online; otherwise, you can do so via a paper form or over the phone.
You do not need to submit an application or undergo a credit check or verification of employment since your policy’s cash value acts as collateral for a loan. You may, however, need to prove your identity to your insurance company. Once you’ve been approved for a loan policy, you can expect to receive the funds within 15 days, though this timeline varies depending on your insurer and loan amount.
Should You Borrow Against Life Insurance?
If you need access to cash, a life insurance loan may be a better option than a personal loan or a cash advance from a credit card since it usually comes with lower interest rates and flexible repayment terms. Additionally, a life insurance loan is often easier to get than a personal loan; you do not need to get an application approved, have your employment status verified, or undergo a credit check.
Then again, you may face serious consequences if you do not repay your policy loan fast enough. This type of loan incurs compounding debt, and if your owed amount grows larger than your policy’s cash value, your policy could lapse. Plus, if you do not repay your loan in full before you pass away, your debt will come out of your death benefit.
- Built-In Collateral
- Few Qualifiers
- Flexible Repayments
- Used at Your Discretion
- Tax Free
- Borrowing Requirements
- Consequences for Nonpayment
- Limited Borrowing Amounts
Advantages:
Consider these benefits of pursuing a policy loan:
- Built-In Collateral: Your policy’s cash value acts as collateral, so you do not need to put up additional collateral.
- Few Qualifiers: If you have a permanent life insurance policy with a sufficient cash value, you qualify to borrow against it without applying or proving anything else (except your identity).
- Flexible Repayments: You do not need to follow a fixed repayment schedule for a life policy loan. You can pay it back at your convenience. This makes life insurance loans a great option if you’re unsure when you can repay your debt.
- Use It For Anything: You can spend your policy loan however you want.
- Tax-Free: As long as your loan balance is smaller than your policy’s cash value, you should not owe income taxes on any of it.
Disadvantages
Taking out a life insurance policy loan does not come without potential drawbacks, such as the following:
- Borrowing Requirements: Your insurance provider may only let you borrow against your life insurance policy if it has reached a minimum cash value.
- Consequences for Not Repaying: If you do not repay your policy loan fast enough and your owed balance exceeds the loan’s cash value, your loan might lapse, and you may owe taxes on any earnings from your life insurance policy. And if you still owe a debt when you pass away, the owed amount will come out of your death benefit.
- Limited Borrowing Amount: Most insurers only let you borrow 90% to 95% of your policy’s cash value.
Alternatives
If your policy has not accumulated a large enough cash value to borrow against it, or you are otherwise ineligible for or uninterested in borrowing against your life insurance policy, you have other options.
Withdrawal
If you have a permanent life insurance policy with a cash value, you can probably withdraw directly from that cash value rather than borrowing against it. If you take this route, as long as you withdraw less than you’ve paid into the policy, you should not have to pay income taxes on the withdrawn funds. Plus, you do not need to repay these funds as you would a policy loan.
However, whatever the terms of your life insurance policy, you may face disadvantages from withdrawal. Withdrawing from your policy will almost always reduce your death benefit, no matter what.
Cash Surrender Value
To access cash through your life insurance policy, you can cancel the policy altogether and receive the surrender value cash payment. Like a cash withdrawal, you would not have to repay these funds.
On the other hand, terminating your life insurance leaves you without coverage. Moreover, canceling your life insurance policy before it matures often incurs steep fees, which would be deducted from the cash surrender value. Your policy’s final cash surrender value is the amount you have paid into the policy (its cash value) minus fees, previous withdrawals, and any outstanding loans. This route should be your last resort if you need cash from your life insurance policy.
How to Pay Back a Life Insurance Loan
Most loans require you to repay your debt on a set schedule, such as through a fixed monthly payment. Life insurance loans, however, do not set a rigid repayment schedule, even for interest payments; you may pay back your debt (plus interest) at any time or not at all.
On the flip side, it’s your responsibility to monitor your life insurance loan, its interest, and its impact on your financial situation. Before taking out your loan, ask your insurer for an in-force policy illustration to see how your loan would impact your policy’s performance in various future scenarios. For example, you may elect to pay back your loan in full, pay only the interest, or borrow the interest.
You should also monitor the interest accumulating on your loan to ensure it does not outgrow your policy’s cash value. To avoid the ramifications of failing to repay your loan, set up autopay.
Consequences of Not Repaying the Loan
Even though you technically do not have a deadline or set schedule for paying back your policy loan, it’s in your interest to pay it back quickly. Your loan’s annual interest rate may be fixed or variable; if you leave your debt unpaid for multiple years, you will face compounding interest.
If you do not pay at least the interest on your loan, the interest will add to your outstanding balance, which could cause your policy to lapse if the balance grows greater than your policy’s cash value. If your policy lapses, any interest you earn on your policy’s investments may become taxable income in the eyes of the IRS. For this reason, keeping up with your premium payments is essential.
Finally, if your loan has an outstanding balance when you die, your insurer will deduct that balance from your death benefit.
Tax Implications of Borrowing From Your Life Insurance Policy
As long as your life insurance policy remains active, you should not owe any income taxes on funds borrowed against the policy. If your policy lapses, however, the IRS may recategorize your loan and any interest your policy earns as taxable income.
If you pass away before repaying your life insurance loan in full, your outstanding balance may come from your death benefit. That amount may not be taxable. However, the tax implications of a life insurance loan can get complicated, especially if you do not plan to repay the loan in full. Consult with an expert, such as your financial advisor, to understand the full picture before pulling the trigger on a policy loan.
Putting It Together
Life insurance loans provide a low-interest, tax-free means of accessing cash without hurting your credit score or tying yourself to a rigid repayment plan. Because you are borrowing against your assets with a policy loan, you can usually get the loan quite easily without undergoing employment verification. Therefore, if you need cash quickly and are unsure when you will be able to pay it back, a life insurance loan could be a great option.
Life insurance loans still accrue interest, and things can get dicey if your outstanding balance exceeds your policy’s cash value. Discuss your options with a financial expert before borrowing against your life insurance policy.