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Borrowing against your life insurance policy

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Life insurance policies are typically purchased to provide financial peace of mind to your family when you pass away. However, several types of life insurance policies have features beyond providing a death benefit. You may be able to borrow money from your insurance company using the cash value portion of your life policy as collateral. If you choose to take out a loan with your insurer, you may want to be sure that you understand how it works first. Bankrate examined some common situations where people borrow against their life insurance policy, but you’ll want to speak with a licensed agent at your insurance company to find out exactly how it works for your policy.

Can you borrow from your life insurance policy?

You can typically take out loans against permanent life insurance policies, but not term life insurance policies. Life insurance loans use cash value accounts as collateral. Term life insurance policies do not come with a cash value account, so policyholders can’t borrow money from their insurer against these policies. A term policy has only one financial consideration—the beneficiary’s death benefit if the insured person dies during the policy term.

Permanent life insurance, such as whole life, is another story. With whole life insurance, a portion of your premium payment will go toward the death benefit, while another part will go into a cash value account that builds value over time.

You may be able to take out a loan from your insurer and use your cash value account as collateral, but enough money will have to have accumulated in the cash value account first. For this reason, you may not be able to take out a loan against a new policy. In addition, if you fail to pay back interest on the loan, the amount you owe could be deducted from the death benefit if you’ve taken out enough money and not repaid it. Policy lapses are bad news if your family is still planning to rely on your life insurance policy.

When you should borrow from your life insurance policy

Borrowing money from a life insurance policy may be a better option than borrowing money from a bank for some policyholders.

Potential benefits include:

  • There is no hard credit check. When taking out life insurance loans, there is typically no impact on the borrower’s credit rating. For those with poor credit, this may be the best way to secure a loan.
  • Only your policy will be used as collateral: When someone’s home is used as collateral, and they default on the loan, they stand to lose their house. If the collateral is the policy, the worst that could happen would be that the life insurance policy would lapse, which could be a more attractive option.
  • Your family may no longer need your death benefit. A widow in her 70s with grown and financially independent children may find a policy loan has more value than leaving money to her heirs.

Disadvantages of taking a loan out on life insurance

While there may be advantages to taking out life insurance loans, borrowing money from your life insurance policy also has some potential drawbacks.

You may want to consider these potential cons before taking out life insurance loans:

  • You risk losing your life insurance policy and incurring tax penalties if the loan is not paid back on time with interest. If payments on the loan stop, the insurer will instead take the money directly from the policy’s death benefit, cash value or dividends, if those are included.
  • Your policy’s cash value can’t be used as collateral until it has built up over time. The amount available to borrow for the first few years is negligible, and it usually takes a decade or so to build up enough reserves to make borrowing worthwhile.
  • Other life insurance policy benefits may also lapse when a loan is taken. For example, for those who have an accelerated benefit rider, which allows the insured person to use a portion of their death benefits for care if they become terminally ill, the amount borrowed may be deducted from the amount available for that purpose.

How to borrow from your life insurance policy

Taking a loan out on life insurance is fairly straightforward. The first step is to determine whether the life insurance policy is one of several types of permanent policies that are eligible for borrowing, including:

Unlike a bank loan, there is no approval process to earn a loan against a life insurance policy. It may also be possible to take the loan as a cash surrender value line of credit to be drawn from as needed.

Interest on the loan will begin to accrue immediately at a rate determined by the insurer, which may be lower than the rate a bank would charge for a similar loan. Loan repayment could begin immediately and is usually broken up into monthly payments.

Frequently asked questions

What is the best life insurance company?

Since everyone has unique needs, there is no one-size-fits-all when it comes to life insurance. It’s usually a good idea to shop around and request multiple quotes from the best life insurance companies. Speaking with a licensed insurance agent may be able to help you determine the best company and policy for you.

Is it worth it to have a permanent life insurance policy if I know I’m going to need a loan?

Many insurance experts recommend considering term policies before whole life insurance policies, but it’s important to speak with a licensed insurance agent to determine what type of policy will work best for your individual needs. Term policies cannot be used for a loan, but these policy types are cheaper than permanent policies, which may help the insured save money and take a smaller loan from another source, such as a bank.

How much does life insurance cost?

The cost of life insurance depends on several personal characteristics, such as age and overall health. For this reason, the best way to find out how much you might pay for a life insurance policy is likely to talk with a licensed insurance agent or to generate quotes from multiple providers.

Written by
Lizzie Nealon
Insurance Writer
Lizzie Nealon is a former insurance writer for Bankrate. Her favorite part of the job is making home, auto and life insurance digestible for readers so they can prepare for the future.
Edited by
Insurance Editor