Can You Borrow Against Term Life Insurance?

A common inquiry revolves around whether one can borrow against a term life insurance policy. Understanding the distinct features of various life insurance products is important when considering such financial maneuvers.

Term Life Insurance and Cash Value

Term life insurance provides coverage for a specific period, such as 10, 20, or 30 years. It is designed to pay a death benefit to beneficiaries if the insured passes away within the specified term. The premiums paid for a term life policy primarily cover the cost of insurance for this defined period.

A defining characteristic of term life insurance is that it does not accumulate cash value. There is no savings or investment component built into a term policy. This means the premiums do not contribute to a growing fund that policyholders can access during their lifetime. Because term life insurance lacks this cash accumulation feature, it is not possible to borrow against it. The policy’s structure is centered solely on providing a death benefit for a temporary duration.

Borrowing Against Permanent Life Insurance

While term life insurance does not allow for borrowing, permanent life insurance policies offer a different structure. Types of permanent life insurance, such as whole life and universal life, include a cash value component that grows over time. This cash value represents a portion of the premiums paid, accumulates interest or investment gains. The growth of this cash value often occurs on a tax-deferred basis, meaning taxes are not due on the gains until the funds are withdrawn.

The accumulated cash value in a permanent life insurance policy serves as a source from which policyholders can borrow. The loan is extended by the insurance company, but it is secured by the policy’s own cash value, which acts as collateral. This financial feature allows policyholders to access funds for various needs without surrendering the policy or impacting the death benefit, provided the loan is managed appropriately.

Policy Loan Mechanics

Taking a loan from a permanent life insurance policy’s cash value operates differently from a conventional bank loan. The insurance company provides an advance against the policy’s cash value, using the policy itself as collateral. Interest is charged on the outstanding loan balance, with typical rates ranging from 5% to 8%. This interest may be fixed or variable, depending on the policy terms.

There is no strict repayment schedule for a policy loan, offering flexibility. However, if the loan, including accrued interest, is not repaid, it will reduce the death benefit paid to beneficiaries. Furthermore, if the loan balance, along with accumulated interest, grows to exceed the policy’s cash value, the policy could lapse, resulting in a loss of coverage. The cash value within the policy generally continues to grow even with an outstanding loan, but it is important to monitor the loan balance to prevent adverse outcomes.