Can You Borrow Money From Your Term Life Insurance?
Understand how life insurance can offer financial flexibility. Learn which policies allow you to access funds during your lifetime and how.
Life insurance primarily provides a death benefit to protect loved ones financially after an individual passes away. Some individuals consider whether their life insurance policy can also serve as a resource during their lifetime, particularly when faced with unexpected expenses or financial opportunities. The ability to access funds from a life insurance policy while still alive depends significantly on the specific type of policy owned and its underlying structure. Exploring these differences helps clarify how life insurance can potentially offer more than just a future payout.
Why Term Life Insurance Lacks Borrowing Power
Term life insurance offers coverage for a specific period, or “term,” such as 10, 20, or 30 years. Policyholders pay premiums for the duration of the term, and if they pass away within that period, the death benefit is paid to their beneficiaries. This type of policy focuses purely on providing a death benefit and does not build any cash value.
The absence of a cash value component is why term life insurance policies do not allow for borrowing. Unlike other types of life insurance, term policies do not accumulate a savings or investment element from which funds can be drawn. Each premium payment primarily covers the cost of insurance for that specific period and administrative expenses.
Since there is no accumulated fund within the policy, there is no collateral against which an insurer can lend money. This structure keeps term life insurance premiums lower than policies that build cash value, reflecting its singular purpose of providing temporary coverage. Therefore, while term life insurance offers valuable protection, it does not provide a mechanism for policyholders to borrow against its value during their lifetime.
Understanding Cash Value in Life Insurance
Cash value is a savings or investment component that accumulates within certain types of permanent life insurance policies, such as whole life or universal life. This accumulated value is distinct from the policy’s death benefit. The cash value grows over time and can be accessed by the policyholder during their lifetime.
A portion of each premium payment is allocated to this cash value component, while another portion covers the cost of insurance and administrative fees. The funds typically grow on a tax-deferred basis, meaning earnings are not taxed until withdrawn or accessed. This tax-deferred growth allows the cash value to compound over many years.
The growth rate of the cash value varies by policy type. Whole life policies often offer a guaranteed interest rate, while universal life policies may have a rate that adjusts or is tied to a market index. As the cash value builds, it becomes a living benefit that the policyholder can utilize for various financial needs.
How to Borrow from Cash Value Life Insurance
Borrowing from a cash value life insurance policy means taking a loan against the accumulated cash value, which serves as collateral. This is not a withdrawal, as the cash value remains intact and typically continues to grow. Policyholders usually do not undergo a credit check or lengthy approval process, as the policy’s cash value secures the loan.
To obtain a loan, contact the insurance company to determine the maximum available amount. Insurers commonly allow borrowing up to 90% of the policy’s accumulated cash value, though this varies by company and policy terms. Once requested, funds can often be disbursed within a few business days.
Interest rates for policy loans are typically variable or fixed, often ranging from 5% to 8%. Interest accrues on the outstanding loan balance. While repayment is flexible with no mandatory schedule, interest payments are generally expected. Some policies may allow interest to be added to the loan balance if not paid, increasing the total amount owed.
Failing to repay the loan or its accrued interest can have significant consequences. If the loan balance, including interest, exceeds the policy’s cash value, the policy can lapse. A lapse with an outstanding loan can trigger a taxable event, where the loan amount exceeding premiums paid may be considered taxable income. Any outstanding loan balance and accrued interest at the time of death will be deducted from the death benefit, reducing beneficiaries’ inheritance. Policy loans are generally tax-free as long as the policy remains in force and does not lapse with an outstanding loan balance.