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Death benefits are typically the feature most often associated with life insurance policies. However, permanent life insurance policies have other advantages, such as the possibility of borrowing against the policy’s cash value. Bankrate’s insurance editorial team has put together some information about what you should keep in mind if you are thinking about borrowing against your permanent life insurance policy.
- You can borrow against a permanent life policy, but not a term policy.
- There is no hard credit check or collateral requirement when borrowing against life insurance.
- Interest accrues when borrowing from cash value, and any outstanding balance will likely reduce the death benefit.
Can I borrow from my 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. This is one benefit of permanent life insurance vs. term life. 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.
If you are considering borrowing from your life insurance policy, keep in mind that it takes time to build cash value. You have to reach a certain threshold before you can take cash value out of the policy, which could mean you are unable to borrow against the policy when you need the money. This differs from a savings account, which allows you to remove money as needed, usually without reaching a certain threshold first.
In addition, if you fail to pay back interest on the loan, the amount you owe could be deducted from the death benefit. Policy lapses can jeopardize your financial protection if your family is still planning to rely on your life insurance policy. For example, if the loan isn’t paid back, interest will continue to accrue, decreasing the policy’s cash value. If the cash value falls to zero and the loan is still outstanding, the policy may lapse, meaning you will no longer have life insurance under that 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. If you have poor credit or have been turned down for a bank loan, borrowing against your life policy may provide the funds your bank will not. It can also provide a way to pay off higher-interest debt, as interest rates tend to be lower than other bank loans or credit cards.
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 borrowed against until it has built up enough 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 death 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 your life insurance policy is one of several types of permanent policies that are eligible for borrowing, including:
- Whole life (also called ordinary life)
- Universal or adjustable life
- Variable life
- Variable universal life
Unlike a bank loan, there is generally no approval process to secure 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 divided into monthly payments.
If you no longer need your life insurance policy, but would like to capitalize on some of the cash value, you could also speak with your life insurance agent about your policy’s potential cash surrender value.
Frequently asked questions
Life insurance rates vary based on several factors, including your age, gender, lifestyle and the policy type and terms. Life insurance companies use these factors to determine your risk class, which they use to determine your premiums.
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 several life insurance companies. Speaking with a licensed insurance agent or your financial advisor may be able to help you determine the best company and policy for you.
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 request quotes from multiple providers.
The timeline for borrowing against a life insurance policy depends on the type of policy and how quickly it accumulates a cash value. Typically, it takes time for the cash value to build up. Often, it can take many years or upwards of a decade to build up a sufficient cash value to make borrowing worthwhile.
The amount you can borrow depends on the cash value of the policy. Typically, the insurer will let you borrow up to 90% of the cash value. However, in some cases, they might allow you to borrow up to 100% of the cash value. Check your policy and talk with your life insurance agent to determine how much you can borrow.