Can You Borrow Money From Term Life Insurance?

Term life insurance does not allow you to borrow money directly from the policy. It provides coverage for a specific period, or “term,” designed to pay a death benefit to your beneficiaries if you pass away within that timeframe. Term life functions primarily as pure protection, lacking a component from which funds can be borrowed during the insured’s lifetime.

Understanding Term Life Insurance

Term life insurance offers a death benefit for a predetermined number of years, typically ranging from 10 to 30 years. Premiums primarily cover the cost of insurance, meaning these policies do not accumulate any cash value over time.

Cash value is an internal savings component that builds within certain types of policies. This component grows and can be accessed by the policyholder. Since term life insurance lacks this accumulation feature, there is no fund against which to borrow.

Upon expiration, the policy ends, and coverage ceases. This characteristic underscores its nature as temporary, pure protection, devoid of any savings or investment element that could serve as collateral for a loan.

Borrowing from Cash Value Life Insurance

While term life insurance does not allow for borrowing, other types with a cash value component do. These are permanent life insurance policies, such as whole life and universal life, designed to provide coverage for the insured’s entire life.

A portion of premiums paid into these permanent policies accumulates cash value over time. This cash value often grows on a tax-deferred basis. The policyholder can access this accumulated cash value through various methods, including taking a policy loan.

A policy loan is not a withdrawal of the cash value itself, but a loan taken against it. The cash value acts as collateral for the loan, remaining within the policy and continuing to earn interest or dividends. The insurance company lends its own money, using the policy’s cash value as security.

Process and Implications of Policy Loans

Before requesting a policy loan, policyholders should confirm their available cash value and any outstanding loan balances. Insurance companies generally allow borrowing up to a certain percentage of the policy’s cash value, often up to 90%.

To obtain a policy loan, the policyholder contacts their insurance company. Unlike traditional bank loans, policy loans typically do not require a credit check or a lengthy approval process, as the policy’s cash value serves as collateral. Funds are usually disbursed within a few business days.

Policy loans accrue interest, which typically ranges from 5% to 8%. While there is no strict repayment schedule, interest continues to accumulate on the outstanding balance. Policyholders can choose to repay the loan at their discretion, or not at all.

If the loan and its accrued interest are not repaid during the insured’s lifetime, the outstanding balance will be deducted from the death benefit paid to beneficiaries. A substantial risk of policy loans is the potential for the policy to lapse if the loan balance, combined with accrued interest, exceeds the policy’s cash value.

Should a policy lapse due to an unpaid loan, the policyholder loses their life insurance coverage. If the policy lapses or is surrendered with an outstanding loan, the amount of the loan exceeding the policy’s cost basis can become taxable income. This can result in an unexpected tax liability, even if the policyholder does not receive cash from the policy’s termination.