Can I Borrow Against a Life Insurance Policy?

For individuals holding certain types of life insurance, a policy loan can present an option to tap into accumulated value within their coverage. This approach allows policyholders to leverage their insurance asset to meet immediate financial requirements. Understanding the fundamental nature of these loans can provide clarity on how they function and their potential utility.

Policies Allowing Loans and Loan Principles

Life insurance policies that accumulate cash value are generally eligible for policy loans. These typically include permanent life insurance types, such as whole life, universal life, variable universal life, and indexed universal life. A portion of the premiums paid into these policies contributes to this cash value, which grows over time on a tax-deferred basis. Term life insurance, designed for a specific period and without a savings component, does not build cash value and therefore cannot be used for policy loans.

The cash value represents a living benefit component of these permanent policies, distinct from the death benefit paid to beneficiaries. Policy loans are not considered a withdrawal of this accumulated cash value. Instead, they function as a loan taken against the cash value, using it as collateral. The insurance company lends the funds, and the policy remains in force, continuing coverage.

The policy’s cash value secures the loan, meaning there is no requirement for a credit check or external collateral. Insurers commonly allow borrowing up to a certain percentage of the cash value, often around 90% or 95%. It takes several years for sufficient cash value to build within a policy to make a meaningful loan possible, with waiting periods ranging from two to ten years or more depending on the policy type and funding.

Financial Characteristics of Policy Loans

Policy loans accrue interest. Interest rates vary by insurer and policy type, but are often competitive, ranging from 5% to 8%. Some policies offer fixed interest rates, providing predictability, while others feature variable rates that can adjust over time, often tied to a benchmark.

Policy loans have a flexible repayment structure. Unlike conventional loans, there is no strict repayment schedule or mandatory monthly payments. However, interest continues to accrue on the outstanding loan balance, and if not paid, it is added to the principal, causing the loan amount to grow.

An outstanding loan impacts the policy’s death benefit. If the policyholder passes away before the loan is fully repaid, the outstanding loan balance, plus any accrued interest, is deducted from the death benefit paid to beneficiaries. A substantial risk arises if the loan balance, including accrued interest, grows to exceed the policy’s cash value. Should this occur, the policy may lapse, leading to a loss of coverage.

The tax implications of policy loans also warrant attention. Funds received from a policy loan are generally not considered taxable income as long as the policy remains in force. However, if the policy lapses or is surrendered with an outstanding loan, the amount of the loan that exceeds the premiums paid (the policy’s basis) may become taxable income. This can create an unexpected tax liability.

Applying for a Policy Loan

Obtaining a life insurance policy loan is generally straightforward, leveraging the policy’s existing cash value. There is no need for a credit check or a lengthy application process, as the policy’s cash value serves as collateral.

To initiate a loan, policyholders contact their insurance provider directly. This can be done through various channels, including online portals, by phone, or via mail. Required information includes the policy number, desired loan amount, and identity verification. Insurers provide specific forms that need to be completed and signed by the policyholder.

Once the application is submitted, processing time varies, but funds are disbursed quickly. Many insurers process loan requests within one to two weeks, with some offering expedited digital options that may take only a few days. Funds are disbursed via electronic funds transfer (EFT) directly to a bank account or by check.