Can I Get a Loan on My Life Insurance Policy?

Qualifying Policies and Cash Value

Accessing a life insurance policy loan depends on the type of policy held, as not all life insurance contracts are designed to accumulate loan-eligible funds. Permanent life insurance policies, such as whole life, universal life, variable universal life, and indexed universal life, build a cash value component. These policies provide coverage for the entire lifetime of the insured, and a portion of the premiums paid contributes to this growing cash value. In contrast, term life insurance policies, which offer coverage for a defined period, do not accumulate cash value and therefore cannot be used to obtain a loan.

The cash value within a permanent life insurance policy represents a living benefit that grows over time. It is essentially a savings component that accumulates on a tax-deferred basis, meaning earnings on this portion are not taxed until they are withdrawn or the policy lapses under certain conditions. This accumulated sum can be accessed by the policyholder during their lifetime, with the loan using this cash value as collateral. The insurer places a lien against this accumulated value, ensuring the loan is secured.

The amount available for a policy loan is not the entire cash value, but rather a significant percentage of it. Insurers allow policyholders to borrow up to 90% or even 95% of the accumulated cash value. It takes several years for a policy to build sufficient cash value to support a meaningful loan, with some policies requiring 2 to 5 years, and potentially longer to reach a substantial loan amount. The specific amount available and the timeline depend on the policy’s terms and the rate at which cash value has accrued.

Understanding Policy Loan Mechanics

A life insurance policy loan operates distinctly from typical loans obtained from banks or other financial institutions. When a policyholder takes out such a loan, they are accessing funds directly from the insurance company itself, not a third-party lender. The cash value within the policy serves as the sole collateral for this internal transaction, and the policy continues to remain in force, providing ongoing coverage, provided premiums are maintained.

Interest accrues on the outstanding loan balance, similar to other forms of debt. The interest rate for policy loans can be either fixed or variable, depending on the specific policy terms and the insurer’s offerings. Fixed rates provide predictability, while variable rates may fluctuate with market conditions. This interest is calculated on a simple interest basis and can be paid directly by the policyholder or, if not paid, it is added to the principal loan balance, causing the loan to grow over time.

Since the loan is fully secured by the policy’s cash value, the insurer does not need to assess the borrower’s creditworthiness or income. Approval is generally granted as long as the policy has accumulated sufficient cash value to support the requested loan amount.

Unlike conventional loans with rigid repayment schedules, life insurance policy loans offer flexibility. There is no fixed repayment timetable, allowing policyholders to repay the loan at their own pace, make partial payments, or even choose not to repay it during their lifetime. The loan balance, including any accrued and unpaid interest, continues to grow. This growth can diminish the policy’s overall value over time.

The presence of an outstanding policy loan directly impacts the policy’s death benefit. If the policyholder passes away with an unpaid loan, the outstanding loan balance, along with any accrued interest, is subtracted from the death benefit paid to the beneficiaries. This reduction means the beneficiaries will receive a smaller payout than the policy’s face amount.

Life insurance policy loans are considered income tax-free as long as the policy remains in force. The funds received are viewed as an advance against the policy’s cash value, not as taxable income. However, a tax event can occur if the policy lapses or is surrendered while an outstanding loan balance exists. If the loan amount, combined with any other withdrawals, exceeds the total premiums paid into the policy (the cost basis), the excess amount can become taxable income.

The Policy Loan Process

Initiating a life insurance policy loan involves a straightforward process with the insurance company. Policyholders can contact their insurer directly, often through a customer service line, an online policyholder portal, or by submitting a written request via mail. The primary information required includes the policy number and the specific loan amount desired, ensuring the request aligns with the policy’s available cash value.

Once the loan request is submitted and verified against the policy’s cash value, the insurer processes the disbursement of funds. Fund delivery can vary, commonly including a physical check mailed to the policyholder or an electronic transfer directly into a designated bank account. Some insurers can disburse funds within a few business days.

Managing the repayment of a life insurance policy loan offers substantial flexibility. Policyholders have several options, including making a single lump-sum repayment, consistent partial payments, or simply paying only the accruing interest. Some policyholders may choose to make no payments at all, allowing the loan balance to grow and be deducted from the death benefit.

Choosing not to repay the loan carries financial consequences for the policy. As unpaid interest is added to the principal, the outstanding loan balance continuously increases, which further diminishes the policy’s net cash value and subsequently reduces the death benefit available to beneficiaries. A risk arises if the growing loan balance, including accrued interest, eventually exceeds the policy’s cash value. In such an event, the policy can lapse, leading to the termination of coverage and potential tax liabilities on the outstanding loan amount.

An outstanding policy loan also impacts the policy’s surrender value, which is the amount a policyholder would receive if they chose to terminate the policy. The loan balance is subtracted from the cash value when calculating the surrender value, reducing the amount the policyholder would receive. Life insurance policy loans are private transactions between the policyholder and the insurer, meaning they are not reported to credit bureaus. This ensures the loan does not directly impact the policyholder’s credit score.