Needing cash can leave you wondering whether you can borrow from your life insurance policy. The quick answer is you can if you have the correct type of life insurance that enables that flexibility.
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Can a Life Insurance Policy Be Used to Pay Off Debt?
Life insurance can be used to pay off debt and many other uses. However, it depends on the type of insurance policy you have. When it comes to life insurance policies, some have a cash value option, often found in whole life insurance policies and some other permanent insurance policies. Standard-term life insurance does not offer a cash-out option. With a whole life insurance policy, you can access that money to pay off debt or spend it any way you want.
There are some stipulations to borrowing money from your life insurance. The main requirement is that you’ve accrued enough cash value in your policy to cover your borrowing amount. Interest is charged when borrowing money from your policy, but it may be lower than traditional loans.
What Types of Life Insurance Policies Can You Borrow From?
The first step in determining if you can borrow from your life insurance is understanding your policy type. While more expensive, whole-life policies often include a cash-out or cash-value option, meaning you could borrow against it. Alternatively, while term life insurance is less expensive, it does not typically include a cash-out or cash-value option, meaning you cannot borrow against it.
With a term policy, you have a pre-specified length of time in which the policy is valid. Your beneficiaries will receive the life insurance benefit if you die before that date. There is no payout if you outlive the date without renewing the policy or converting it.
Whole life insurance allows you to borrow cash. With this policy, there is a payout to beneficiaries when you die, and no time limit is in play. If your policy pays out $1 million upon your death, but you need to borrow $100,000 to pay off debt while you’re still living, you can. Note that if you do not repay the amount borrowed, it reduces the death benefit by that amount and any outstanding interest, which in this case would be $100,000 plus interest.
Pros for Borrowing from Life Insurance
Suppose you have a permanent or whole life insurance policy and find that you need a loan. In that case, there are some significant benefits to skipping a personal bank loan and borrowing against your life insurance policy.
One benefit is that you do not have to qualify for a loan. You can access it if you have enough in the cash value portion of your policy. There’s also no credit check, so that will not appear on your credit report.
If you’re considering a personal loan or taking cash out from your credit card, you’ll find borrowing from your life insurance may have a lower rate. There are also more options for repayment. You might not have to pay it back at all.
How Much Can You Borrow from Life Insurance?
Each whole life insurance policy will have different rules on how much you can borrow. One common rule is that you can borrow up to 90% of your accrued cash value. If you’ve accrued $100,000, you can borrow up to $90,000. The longer you’ve had the policy, the more likely you will have a large amount saved.
What Kind of Debt Can Get Paid Off?
There are no specific types of debt for which the borrowed money can or cannot be used. That said, you will still be paying interest, so you want to make sure it’s a sound financial decision for your situation.
For example, if you’re struggling with credit card debt and your interest rate is high while the interest rate on a loan from your life insurance is much lower, you’re better off taking out the loan and paying off the credit card. You’ll still be repaying that money but at a lower rate.
Another example is if you have an unexpected bill that’s hard for you to pay off, such as a medical bill, and you have difficulty getting a personal loan. This is a prime time to use that life insurance cash value.
Cons Against Borrowing from Life Insurance
Borrowing against your life insurance policy can have some downsides. The biggest one is that there are interest charges. Whether you plan on repaying the amount you’ve cashed out or not, you’ll still have to pay the interest, or it will be added to the loan balance.
Sometimes, you can subtract the interest from the cash-out portion, so it does not come out of your pocket. Doing this drains money from the death benefit, so there is less for your beneficiaries when you die. If you hit a point where you’ve borrowed more than the policy is worth, it will likely be canceled.
Another downside is that you cannot borrow from your cash value until you’ve accumulated a significant amount, which can take an extended time.
Tax Implications of Borrowing from Life Insurance
The interest you’re paying on your life insurance loan is not tax-deductible. However, one thing to keep an eye out for is borrowing more than your cash value, lapsing your policy. This can lead to a taxable event, and you may have to pay additional taxes.
Paying Back the Loan
Paying back the loan is not always necessary, and there are no regular required payments. However, it may reduce the death benefit if you do not pay the loan back. If you wish to repay the loan, you can do it in one lump sum, over time with recurring payments, or pay it sporadically.
If you decide not to repay the loan, it’s important to remember that you’ll keep paying interest on the borrowed amount.
Should I Take Out a Loan Against My Life Insurance Policy?
Before deciding if you should take out a loan from your whole life insurance, you need to look at what the loan is for, what all of your options are, and weigh the pros and cons.
Sometimes borrowing against life insurance can save you money and help you get out of debt. In other situations, this is not the best choice and can lead to policy termination.