Can I Take a Loan Out of My Life Insurance?

A life insurance loan provides a way to access the accumulated cash value within a permanent life insurance policy. This type of loan differs from a traditional bank loan because it is an advance against your own policy’s value, not borrowed funds from an external lender. Because the loan is secured by your policy’s cash value, a credit check is not required.

Policies That Allow Loans

Only life insurance policies that build cash value offer the option of taking a loan. These are generally referred to as permanent life insurance policies, which include types such as Whole Life, Universal Life, and Variable Universal Life insurance. Cash value functions as a savings component within the policy, growing over time on a tax-deferred basis. As premiums are paid, a portion goes towards the cost of insurance, and the remainder contributes to this accumulating cash value.

In contrast, term life insurance policies do not accumulate cash value. Term life insurance provides coverage for a specific period and is designed purely for death benefit protection. Therefore, if you hold a term life insurance policy, you cannot take a loan against it because there is no cash value component to borrow from.

How a Life Insurance Loan Functions

A life insurance loan operates by using your policy’s cash value as collateral. The insurance company lends you money, and your policy secures this loan, meaning no credit check or extensive approval process is needed. Some insurers may require the policy to have accumulated cash value for several years before a loan becomes available.

Interest is charged on the outstanding loan balance, with rates typically ranging from 5% to 8%. This interest accrues for as long as the loan remains unpaid. Life insurance loans often do not have a fixed repayment schedule, offering policyholders flexibility. You can choose to repay the principal and interest over time, pay only the interest, or even not repay the loan at all during your lifetime.

It is important to distinguish a loan from a cash value withdrawal. A loan is money borrowed against the cash value, which acts as collateral, and it must eventually be repaid or deducted from the death benefit. A withdrawal, conversely, permanently removes funds from the cash value, reducing the policy’s value and death benefit without any repayment obligation. While a loan keeps the cash value intact as collateral, a withdrawal directly reduces it.

Financial and Policy Impact

Taking a loan from your life insurance policy carries several financial and policy implications. If the loan, along with any accrued interest, is not repaid before the policyholder’s passing, the outstanding amount will be deducted from the death benefit paid to beneficiaries. This means beneficiaries may receive less than the policy’s face value.

The growth of your policy’s cash value can also be affected. While some policies allow the cash value to continue earning interest or dividends even with an outstanding loan, the portion used as collateral may earn a reduced rate or cease earning entirely, depending on the insurer’s terms.

A risk involves the possibility of policy lapse. If the outstanding loan balance, including accrued interest, grows to exceed the policy’s remaining cash value, the policy could lapse. If a policy lapses with an outstanding loan, the unpaid loan amount can become taxable income.

Life insurance loans are generally tax-free as long as the policy remains in force and does not lapse. However, an exception applies to policies classified as Modified Endowment Contracts (MECs). If a policy becomes a MEC, loans are treated as taxable distributions. If the policyholder is under age 59½, these taxable distributions from a MEC may be subject to a 10% penalty.

Accessing Your Policy’s Cash Value

Initiating a loan against your life insurance policy generally involves a straightforward process once the policy has accumulated sufficient cash value. You will need to gather basic information, such as your policy number and the desired loan amount. Some insurers require a minimum cash value before a loan can be taken.

To request the loan, contact your insurance company directly. This can be done through various methods, including phone, an online portal, or by submitting a specific loan request form. The process is less complex than applying for a traditional bank loan, as there is no credit check involved.

Once your request is submitted, the insurance company will process it. Funds are often disbursed within a few business days or up to a few weeks. The insurer will provide documentation detailing the loan terms, the applicable interest rate, and any available repayment options.