One of the benefits of buying permanent life insurance is the cash value it builds. This savings account can be borrowed against or withdrawn from while you are still alive. Although it may be tempting to borrow from life insurance, it could lower the death benefit if you don’t pay the loan back in full before you die. Before you take out life insurance loans, consider the pros and cons to help you decide if it’s in your best interest to do so. If you wish to preserve the full death benefit for your beneficiary, you might want to also consider dipping into savings, taking out a personal loan or opening a home equity line of credit (HELOC).

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How do I take a loan from my life insurance policy?

To take a loan from your life insurance policy, you must first have the right type of policy. Permanent life insurance policies are the only type of life insurance you can take a loan from. Part of the policy is a cash value savings account. The insurance company will take a portion of each premium payment and add it to the cash value account. Over time, the cash value will grow, tax-deferred and with interest. How fast it grows depends on the type of permanent life insurance policy you have:

  • Whole life insurance policy: Sets a fixed monthly premium over the life of the policy with a guaranteed death benefit. Cash value automatically builds up at a minimum guaranteed rate.
  • Universal life insurance policy: Offers additional flexibility to have a monthly payment divided into two parts: One covers life insurance and the other goes into savings and investment to help build cash value.
  • Variable universal life: Combines a death benefit with a savings account that allows you to invest in stocks, bonds and other vehicles you choose. You can grow your policy more quickly but also take on the risk the comes along with becoming an investor.

Once you reach a certain cash value balance determined by your insurer, you are eligible to take a loan against it. There are no credit checks or application process to take a life insurance loan. You request a loan amount from the insurer and they set up the loan and determine the interest rate. There are no set repayment terms like with a bank loan.

Although you don’t have to pay the loan back, it is wise to do so. Not paying it back could cause the policy to lapse if the amount exceeds the cash value account balance. If you die before the loan and interest are fully paid back, the outstanding balance will be deducted from the death benefit amount owed to your beneficiary.

What is cash value?

Cash value is a specific portion of your permanent life insurance policy that earns interest and remains separate from your death benefit. When you buy cash value life insurance, your premium pays for the cost of insurance and overhead and fees. The rest goes to your cash value account.

Once you build up enough cash value (as determined by the insurance company and policy type), you can access the account to use while you’re alive. You can use cash value to pay premiums, take out a loan or make a partial withdrawal. If you no longer need the death benefit, you can also sell the policy for a cash settlement or surrender the policy for the cash surrender value.

Keep in mind that, while money borrowed from your cash value account that is not paid back will diminish your death benefit, the cash value account is not actually part of your death benefit and will most likely be returned to the life insurance company when you pass away.

The pros and cons of life insurance loans

With any type of loan, there are pros and cons to consider before signing the loan agreement. Life insurance loans are no different. There are some advantages to them that might make taking a loan from your cash value the best decision, but there are also disadvantages that could mean you have better options elsewhere. Consider these pros and cons of life insurance loans before making a final decision, and think about consulting a certified financial planner to ensure you make the right choice for your situation.

Life insurance loans pros and cons

Pros Cons
Tax benefits: Cash value grows tax-deferred, and if you take a loan, it is tax-free, though interest will accrue. Death benefit could be reduced: If you don’t pay the loan amount and interest back in full before death, the outstanding balance will reduce the death benefit amount your beneficiary will receive.
No set payment terms: Unlike a traditional loan, there are no set repayment terms. You can pay back the loan monthly, quarterly, annually or decide not to pay it back at all, though this will lower your death benefit when claimed. Interest will accrue and can compound: The insurance company determines the interest rate when you take out a loan, which can be anywhere from 5 to 9 percent. Unpaid interest can compound, causing the loan balance to grow if not paid down.
No credit check: There is no credit check or qualification process. Even if you have poor credit or no credit, you can still take a loan against your life insurance cash value. The policy could lapse: If the loan grows beyond the cash value account balance, it could cause the policy to lapse. If the policy lapses, there will be no death benefit for your beneficiary when you pass away.

Frequently asked questions

    • The best life insurance company is one that meets your coverage needs and other factors that are important to you. Although policy price is important, there are other factors to consider, like customer claim satisfaction or available riders to customize your policy. Consider reviewing the company’s financial strength rating, which shows its historic ability to pay life insurance claims. Once you determine which companies fit your desired profile, get quotes to compare so you can find the carrier with the best value for your coverage needs.
    • How much life insurance you need depends on several variables. If you have dependents, how many years of income replacement do you need? Are you the breadwinner or a dual income family? If your spouse stays at home to raise the children, do you want them to remain in that role? Do you want your beneficiary to continue the same lifestyle? If so, for how long? Answering these questions can help you determine your coverage needs. You can also use a life insurance calculator and speak with a financial planner to help you determine how much life insurance to buy.
    • When deciding between term versus whole life insurance, consider your coverage needs. Are they temporary needs, like paying off debt, or permanent needs, like paying for final expenses? Many people turn to term life insurance because it’s cheaper, but it only lasts for a set number of years. While whole life insurance is more expensive, it lasts for your lifetime and has guaranteed level premiums. You may decide one policy is better than the other to meet your needs, or find that a hybrid approach is best to cover all your life insurance needs.