Can You Borrow Against Your Term Life Insurance Policy?

Term life insurance policies generally do not allow policyholders to borrow against them. This type of insurance is designed to provide a death benefit for a specific period. It does not accumulate cash value, which is the component against which loans are typically made.

The Nature of Term Life Insurance and Cash Value

Term life insurance provides coverage for a defined period, known as the “term,” which can range from 10 to 30 years. If the insured individual passes away within this term, a death benefit is paid to the designated beneficiaries. This type of policy is straightforward, focusing purely on providing financial protection for a set duration.

A fundamental characteristic of term life insurance is its lack of a cash value component. Unlike some other life insurance types, term policies do not build an accumulated savings or investment portion. Premiums paid for term life insurance primarily cover the cost of the death benefit for the specific term. Because there is no cash value built within a standard term life policy, there is no asset for the policyholder to borrow against.

Life Insurance Policies That Allow Borrowing

Permanent life insurance policies are designed to accumulate cash value, making loans possible. A portion of the premiums paid into these policies contributes to this cash value, which grows over time on a tax-deferred basis. This accumulated cash value serves as an asset that policyholders can access during their lifetime.

Whole life insurance provides lifelong coverage and guarantees a fixed premium. It features guaranteed cash value growth, often at a fixed interest rate, and may also offer dividends from mutual insurers, which can further enhance cash value. Universal life insurance offers flexibility, allowing adjustments to premiums and death benefits, with cash value growth tied to interest rates. Variable universal life insurance links cash value growth to sub-accounts that invest in the market, offering potential for higher returns but also carrying investment risks.

How a Life Insurance Policy Loan Works

A policy loan allows access to the cash value within a permanent life insurance policy. The amount available for a loan is typically a percentage of the policy’s accumulated cash value, often up to 90%. No formal loan application or credit check is required because the loan is secured by the policy’s cash value. The policy itself serves as collateral for the funds borrowed.

These loans accrue interest, with rates typically ranging from 5% to 8%, which can be lower than traditional bank loans. While there is no rigid repayment schedule, interest continues to accumulate on the outstanding balance. If the loan, including accrued interest, is not repaid before the insured’s death, the outstanding balance will reduce the death benefit paid to beneficiaries. A significant risk arises if the loan balance, including interest, grows to exceed the policy’s cash value, which can cause the policy to lapse. If a policy lapses with an outstanding loan, the loan amount that exceeds the premiums paid can become taxable income to the policyholder.