Can You Borrow Against a Life Insurance Policy?
Understand how certain life insurance policies allow you to access their accumulated value. Explore the process, implications, and repayment flexibility.
A life insurance policy loan allows policyholders to access funds from their coverage while alive. Policyholders can borrow directly against the accumulated cash value within specific types of life insurance policies. Unlike a traditional bank loan, this process does not involve a credit check or a formal approval process. The loan is secured by the policy’s own cash value, allowing utilization of assets without surrendering coverage.
Policies That Allow Loans
Only certain types of life insurance policies that accumulate cash value permit policy loans. These policies are known as permanent life insurance, providing coverage for the policyholder’s entire life. A portion of the premium payments in these policies contributes to a cash value component, which grows over time on a tax-deferred basis.
Whole life insurance is a type of permanent policy that builds cash value at a fixed interest rate, offering guaranteed growth and predictable access to funds through loans. Universal life insurance also accumulates cash value, but it provides more flexibility, allowing adjustments to premiums and death benefits while the cash value growth rate can vary, often with a guaranteed minimum interest rate. Variable universal life insurance further allows the cash value to be invested in various sub-accounts, similar to mutual funds, linking its growth to market performance, which offers potential for higher returns but also greater risk. Policyholders can typically borrow against the cash value in these policies once sufficient funds have accumulated, which usually takes several years.
Conversely, term life insurance policies do not build a cash value component. Therefore, it is not possible to borrow against a term life insurance policy, as there is no cash fund to serve as collateral for a loan. Term policies provide a death benefit for a specified period, without the savings or investment features of permanent life insurance.
Taking a Policy Loan
Initiating a life insurance policy loan is straightforward. Policyholders typically begin by contacting their insurance provider to confirm the available loan amount. Insurers typically allow borrowing up to 90% of the policy’s current cash value.
No credit check, formal approval, or income verification is required. The policy’s cash value serves as the sole security for the loan, simplifying access to funds. Once the request is submitted, which can be done via phone or online portal, funds are generally disbursed within 5 to 10 business days, often through check or direct deposit.
Loan Mechanics and Policy Impact
A life insurance policy loan functions as a lien against the policy’s cash value. This means the cash value continues to grow, potentially earning interest or investment gains, even while the loan is outstanding. Interest accrues on the loan balance, typically at a fixed or variable rate, often ranging from 5% to 8%.
An outstanding loan directly impacts the policy’s death benefit. If the policyholder dies before repaying the loan, the outstanding loan amount, plus any accrued interest, is deducted from the death benefit paid to beneficiaries. A risk arises if the outstanding loan balance, including accrued interest, exceeds the policy’s cash value. In such cases, the policy can lapse, leading to the termination of coverage and potential tax implications on the borrowed amount. For participating policies, dividends may also be affected by an outstanding loan.
Repaying a Policy Loan
Repaying a life insurance policy loan offers flexibility, differing from traditional bank loans. There is typically no fixed repayment schedule, allowing policyholders to repay the loan at their own pace, or even choose not to repay it at all. Payments are generally applied first to accrued interest, then to the principal balance.
Making repayments helps restore the policy’s full cash value and, consequently, the original death benefit. Repaying the loan reduces the amount deducted from the death benefit, ensuring beneficiaries receive the full intended payout.
Conversely, if the loan is not repaid, the outstanding balance and accrued interest will permanently reduce the death benefit. If the loan and interest exceed the cash value, the policy may lapse, leading to loss of coverage. Repayment methods include sending a check, making online payments, or utilizing policy dividends to offset the loan.