Can You Borrow Against a Term Life Insurance Policy?

Life insurance offers security for families, providing a financial safety net. Beneficiaries receive a sum of money upon the policyholder’s passing, which can cover expenses like daily living costs, debts, and education. Beyond its primary function of death benefit protection, some life insurance policies also allow access to accumulated value during the policyholder’s lifetime. The ability to borrow against a policy depends on its structure and whether it builds accessible value.

Understanding Term Life Insurance

Term life insurance provides coverage for a specific period, such as 10, 20, or 30 years. It pays a death benefit to beneficiaries only if the insured passes away within the specified term. This type of insurance is often selected for its affordability and straightforward nature, making it a suitable option for individuals seeking substantial coverage at a lower initial cost compared to permanent policies.

Term life insurance lacks a cash value component. Unlike other policy types, term policies do not accumulate a savings or investment portion over time. Premiums primarily cover the death benefit for the given period.

Because term life insurance does not build cash value, it cannot be borrowed against. If the policyholder outlives the term, coverage expires, and no funds are returned unless a “return-of-premium” rider was purchased, which typically comes with higher costs.

The absence of a cash value component means term life insurance generally has lower premiums than permanent options. It is a cost-effective choice for temporary financial obligations, such as a mortgage or supporting dependents through a specific life stage.

Understanding Policies With Cash Value

Unlike term life insurance, certain policies accumulate cash value over time. These permanent life insurance policies include whole life and universal life. They provide coverage for the policyholder’s entire life, as long as premiums are paid.

Whole life insurance offers a guaranteed cash value growth rate and fixed premiums. A portion of each premium is allocated to the cash value, which grows tax-deferred. This cash value increases predictably, providing a stable financial resource.

Universal life insurance also accumulates cash value, offering flexibility in premium payments and death benefits. Cash value growth can be tied to insurer interest rates or a stock market index, often with guaranteed minimums and caps. This flexibility allows for adjustments based on changing financial circumstances.

The accumulated cash value in these permanent policies can be accessed through policy loans. The policy’s cash value serves as collateral. These loans do not require a credit check or formal application, as the cash value provides security.

Policy loans from cash value life insurance do not trigger taxable income, provided the policy remains in force and is not surrendered or allowed to lapse. However, if the policy lapses or is surrendered with an outstanding loan, the borrowed amount exceeding premiums paid could become taxable income. Interest accrues on policy loans, and while repayment schedules are often flexible, any unpaid loan balance, including accrued interest, will reduce the death benefit.

Common Loan Options

Individuals seeking funds, since term life insurance cannot be borrowed against, may explore other common lending avenues. These options are distinct from life insurance policy loans and do not involve the insurance contract itself.

Personal loans are a widely available option from banks, credit unions, and online lenders. These can be secured or unsecured. An unsecured personal loan does not require collateral and is approved based on creditworthiness, including credit score and income. Unsecured loans are used for various purposes, such as consolidating debt, covering unexpected expenses, or funding major purchases.

A secured personal loan requires pledging an asset, like a vehicle or savings account, as collateral. This reduces lender risk, potentially allowing for lower interest rates or larger loan amounts. However, failure to repay can result in the lender seizing the pledged asset.

Home equity loans and Home Equity Lines of Credit (HELOCs) allow homeowners to borrow against their property’s equity. A home equity loan provides a lump sum of money, typically with a fixed interest rate, and is repaid over a set period. This option is often suitable for one-time, large expenses like home renovations.

A HELOC functions as a revolving line of credit. It allows drawing funds as needed up to a predetermined limit over a specific draw period, usually with a variable interest rate. HELOCs offer flexibility for ongoing or unpredictable expenses, as interest is only paid on the amount borrowed. Both use the home as collateral, meaning the property could be at risk if the borrower defaults on the loan.