Can I Take Out a Loan on My Life Insurance?
Unlock your life insurance cash value. Learn how policy loans work, their impact, and how to manage them effectively.
A life insurance loan provides a way for policyholders to access funds from the cash value accumulated within certain types of life insurance policies. This mechanism is not a traditional loan from a bank or third-party lender. Instead, it functions as an advance provided by the insurance company, using the policy’s cash value as collateral. The policy’s death benefit secures this advance, and no credit check is required.
Policies That Allow Loans
Not all life insurance policies allow for loans, as only those that accumulate cash value offer this feature. Policies such as whole life, universal life, and variable universal life build cash value, making them eligible for loans. Term life insurance policies, conversely, do not accumulate cash value and therefore do not permit loans.
Cash value represents a portion of the premiums paid that grows on a tax-deferred basis within the policy. This accumulated value serves as the collateral for a policy loan. The ability to access this cash value becomes available after a certain period, as sufficient premiums must be paid for the cash value to grow.
Understanding the Loan Process
A life insurance loan is an advance against the policy’s cash value, not a withdrawal of funds from the policy itself. This means the cash value continues to grow, potentially earning interest or dividends, even while a loan is outstanding. To obtain a loan, policyholders contact their insurer and submit a request; there is no credit check or extensive approval process, as the policy’s cash value acts as collateral. Funds can be disbursed within a few days.
Interest accrues on the loan balance, similar to other types of loans, and rates are set by the insurer, ranging from 5% to 8%. These rates can be fixed or variable. The outstanding loan balance, including any accrued interest, reduces the death benefit paid to beneficiaries if the policyholder passes away before repayment. This reduction can impact the financial security intended for loved ones.
Managing Your Life Insurance Loan
Unlike conventional loans, life insurance policy loans offer significant flexibility regarding repayment. Policyholders are not bound by strict repayment schedules or deadlines and can choose to repay the loan at their own pace, make partial payments, or even opt not to repay it at all. However, if the loan is not repaid, the outstanding balance and accumulated interest will be deducted from the death benefit when the policy matures or the insured dies.
A significant risk of non-repayment is the potential for policy lapse. If the outstanding loan balance, including accrued interest, grows to exceed the policy’s cash value, the insurance company may terminate the coverage. This not only results in the loss of life insurance protection but can also trigger adverse tax consequences. Loan proceeds are generally not considered taxable income if the policy remains in force. However, if the policy lapses or is surrendered with an outstanding loan, the portion of the loan that exceeds the premiums paid into the policy may become taxable income.