Can You Borrow Money Against Your Life Insurance Policy?

It is possible to borrow money against a life insurance policy, though this capability is not universal. This option allows policyholders to access funds from their policy’s accumulated value without a traditional bank loan. The process and implications of such a loan differ significantly from conventional borrowing.

Policy Eligibility for Loans

The ability to borrow against a life insurance policy is exclusively tied to policies that build cash value. Cash value represents a savings component that accumulates over time within certain permanent life insurance policies, growing on a tax-deferred basis. This accumulated value can be accessed by the policyholder during their lifetime.

Policies such as whole life, universal life, and variable universal life insurance are examples of permanent policies that develop cash value. A portion of each premium payment contributes to this cash value, which then grows through interest or investment gains. In contrast, term life insurance policies are designed purely for temporary coverage and do not accumulate cash value.

How Life Insurance Loans Function

A life insurance policy loan is not a withdrawal of your cash value but a loan provided by the insurer, using the policy’s cash value as collateral. The policy remains in force, and the cash value continues to grow, even with an outstanding loan. This means the loan does not deplete the policy’s value but creates an obligation against it.

Interest accrues on the outstanding loan balance, with rates that can be fixed or variable, typically ranging from 5% to 9% annually. Unlike traditional loans, there is usually no mandatory repayment schedule, offering flexibility in how and when the policyholder repays the loan principal and interest. However, any outstanding loan balance, including accrued interest, will reduce the death benefit paid to beneficiaries upon the policyholder’s death. For example, if a policy has a $100,000 death benefit and a $10,000 outstanding loan with $500 in accrued interest, the beneficiaries would receive $89,500.

A risk arises if the outstanding loan amount, combined with accrued interest, exceeds the policy’s cash value. Should this occur, the policy may lapse. If a policy lapses with an outstanding loan, the unpaid loan amount that exceeds the premiums paid into the policy may become taxable income. This can result in substantial taxes on previously tax-deferred gains.

Obtaining a Policy Loan

Initiating a policy loan begins by contacting your life insurance company. Most insurers provide specific forms or an online application process to request a loan. You need to provide your policy number, the desired loan amount, and personal identification details.

The loan amount is usually limited to a percentage of the policy’s accumulated cash value, often up to 90% or 95%. Once the loan request is submitted, the insurer processes it. Funds are typically disbursed via check or direct deposit.

Upon approval and disbursement of the loan, the insurer provides a loan agreement or confirmation statement. This document outlines the loan terms, including the interest rate, outstanding balance, and repayment options. Understanding the loan’s terms and its impact on the policy’s future value is important.