Can You Borrow Against Your Life Insurance Policy?

Policyholders can borrow against a life insurance policy, accessing funds from their coverage during their lifetime. This financial option draws from the accumulated cash value within certain types of life insurance policies. Understanding how these loans function and the process for obtaining them is important. This article explains the types of policies that support loans, their financial mechanics, and the application steps.

Policies That Support Loans

Cash value is a savings component that accumulates over time within certain life insurance policies from premium payments. This accumulation often grows on a tax-deferred basis, meaning taxes on gains are not paid until funds are accessed. Only permanent life insurance policies, designed for lifelong coverage, typically build this cash value and allow for policy loans.

Whole life insurance is a permanent policy with fixed premiums and guaranteed cash value growth. Universal life insurance offers flexibility, allowing adjustments to premiums and death benefits, with cash value growth often tied to current interest rates or market indexes. Variable universal life insurance introduces investment options, where policyholders can allocate cash value into sub-accounts, potentially leading to higher returns but also greater risk. In contrast, term life insurance provides coverage for a specific period and does not include a cash value component. Therefore, term policies do not offer policy loans. The amount available to be borrowed, known as the loan value, is generally a substantial percentage of the accumulated cash value, often ranging from 90% to 95%.

The Mechanics of a Life Insurance Policy Loan

A life insurance policy loan is a loan from the insurer, using the policy’s cash value as collateral, rather than a direct withdrawal. The underlying cash value continues to accrue interest or earn returns as specified by the policy, even while a loan is outstanding. Interest is charged on the loan balance, typically calculated as simple interest. Interest rates for policy loans commonly fall within a range of 5% to 8%, and these rates can be either fixed or variable depending on the specific policy terms.

The policy’s cash value serves as collateral for the loan, meaning the amount available for other uses, such as future withdrawals or policy surrender, is reduced by the outstanding loan balance. If a policyholder passes away with an unpaid loan, the outstanding loan balance plus any accrued, unpaid interest will be deducted from the death benefit paid to the beneficiaries. For example, if a policy has a $500,000 death benefit and a $100,000 outstanding loan, the beneficiaries would receive $400,000. While there is no rigid repayment schedule for policy loans, any unpaid interest will increase the loan balance over time.

Should the total loan balance, including accumulated interest, exceed the policy’s cash value, the policy can lapse. A policy lapse with an outstanding loan may trigger a taxable event. In such cases, the amount of the loan that exceeds the policy’s basis can be considered taxable income by the Internal Revenue Service. Policyholders have several repayment options, including making regular payments of principal and interest, paying only the interest, or choosing not to repay the loan at all. If the loan is not repaid, the outstanding amount is simply subtracted from the death benefit when the policy matures.

Applying for a Life Insurance Policy Loan

To obtain a life insurance policy loan, policyholders typically contact their insurance provider directly. This can be done through various channels, including a phone call to customer service, an online policyholder portal, or by submitting a request via mail. When applying for the loan, required information includes the policy number and the specific amount of funds desired.

For direct deposit of loan proceeds, policyholders will also need to provide their bank account details. Since the loan is secured by the policy’s cash value, a credit check is generally not part of the application process. Once the request is submitted, loan processing times can vary, but funds are often disbursed within a few business days to a week. Some insurers may offer electronic funds transfer to expedite delivery of the borrowed amount.