Can I Borrow Against My Life Insurance?

You can access funds from certain types of life insurance policies through a loan. This option allows policyholders to leverage the accumulated value within their permanent life insurance policy, providing funds without needing a traditional bank loan. Understanding how these loans function and their potential implications is important.

Understanding Life Insurance Loans

A life insurance loan is a financial arrangement where you borrow money from the insurance company, using your policy’s accumulated cash value as collateral. This differs from a withdrawal, which permanently removes funds and reduces the death benefit. A loan is a debt against the policy, with the cash value remaining intact and continuing to grow, even while the loan is outstanding.

Term life insurance does not build cash value, making it ineligible for loans. Permanent life insurance policies, such as whole life, universal life, indexed universal life, and variable life, accumulate cash value over time. These policies allow you to borrow against their value.

Interest accrues on a life insurance loan, with rates often ranging between 5% and 8%, which can be lower than rates for personal loans or credit cards. There is no credit check, income verification, or formal approval process involved. Policyholders have flexibility in repayment; payments are not mandatory, and the loan can remain outstanding, with the balance deducted from the death benefit upon the insured’s passing.

Life insurance loans are not considered taxable income as long as the policy remains active and is not classified as a Modified Endowment Contract (MEC). This tax treatment stems from it being a loan, rather than a distribution of policy earnings. However, if the policy lapses or is surrendered while a loan is outstanding, the loan amount (any gain in the policy exceeding premiums paid) can become taxable income.

Applying for a Life Insurance Loan

Obtaining a life insurance loan is less complex than securing a traditional bank loan, as your policy’s cash value serves as collateral. To initiate a loan request, contact your insurance provider directly. This can be done through their online portal, by phone, mail, or by contacting your insurance agent.

You will need to provide your policy number and specify the desired loan amount. Most insurers allow borrowing up to 90% of your policy’s cash value, though this percentage can vary. A policy needs time, often several years, to accumulate sufficient cash value to support a loan.

Once the loan request is submitted, processing time can vary. It may take a few days to a week for the loan to be processed and funds disbursed. Funds are typically sent via direct deposit or by mailed check.

Managing Your Policy with an Outstanding Loan

Managing a loan taken against your life insurance policy involves understanding repayment options and its ongoing impact. Policyholders are not bound by a fixed repayment schedule. You can repay the loan in a lump sum, make regular payments, or pay only the accruing interest. Repayments are applied first to accrued interest before reducing the principal loan balance.

An outstanding loan directly affects the death benefit. If the loan, plus any accrued and unpaid interest, is not fully repaid by the insured’s death, that amount will be deducted from the death benefit paid to your beneficiaries. This means your beneficiaries will receive a reduced payout. An outstanding loan also impacts the available cash value for future loans or withdrawals, as it uses a portion of that value as collateral.

A key consideration is the risk of policy lapse. If the outstanding loan balance, including accrued interest, exceeds the policy’s cash value, the insurance company may terminate the policy. If this occurs, the policyholder loses coverage, and there can be tax implications.

The outstanding loan amount, to the extent it represents gains within the policy (cash value minus premiums paid), can become taxable as ordinary income. This can result in an unexpected tax liability, especially if the policy has accumulated substantial gains. Policies classified as Modified Endowment Contracts (MECs) have stricter tax rules, where loans are treated as taxable income on a gain-first basis.