Can You Get a Loan From Life Insurance?

You can obtain a loan from a life insurance policy, but this option is available only with specific types of policies. This financial tool allows policyholders to access funds by borrowing against the accumulated value within their own policy. Unlike a traditional loan from a bank, these funds do not come directly from the insurer’s general assets but are secured by your policy’s cash value.

Policy Eligibility and Cash Value

Only permanent life insurance policies, such as whole life, universal life, and variable universal life, accumulate a cash value component that can be borrowed against. Term life insurance policies, in contrast, are designed solely for a set period of coverage and do not build cash value, meaning they do not offer a loan option.

Cash value represents a savings component within a permanent life insurance policy, accumulating over time as a portion of premium payments is allocated to it. This value grows through interest or investment gains, depending on the policy type, and is accessible to the policyholder during their lifetime. The growth of this cash value is generally tax-deferred, meaning that earnings are not taxed until they are withdrawn or accessed. It typically takes several years for the cash value to grow to a substantial amount that can be used for a loan.

Mechanism of a Life Insurance Policy Loan

A life insurance policy loan is not a conventional loan; it is essentially the policyholder borrowing from their own accumulated cash value, with the policy serving as collateral. This unique structure means that obtaining such a loan does not require a credit check or income verification, making it accessible to policyholders regardless of their credit history. The loan is secured by the policy’s value, which reduces risk for the insurer.

Insurers generally allow policyholders to borrow up to a certain percentage of their policy’s cash surrender value, often up to 90%. While you are borrowing your own money, interest is charged on the loan, accruing over time. This interest is typically paid back to the policy, and if it is not paid, it can be added to the outstanding loan balance, a process known as loan capitalization. Interest rates for life insurance loans are often lower than those for personal loans or credit cards, and they can be fixed or variable depending on the specific policy and insurer.

To apply for a policy loan, the policyholder usually contacts their insurance provider or agent and completes a request form. The processing time for these loans can be relatively quick, often taking just a few days to a week for the funds to be disbursed. A distinct characteristic of these loans is their non-recourse nature; the insurer cannot pursue the policyholder for repayment beyond the policy’s cash value.

Loan Repayment and Policy Implications

Life insurance policy loans offer flexibility regarding repayment, allowing policyholders to repay on a schedule that suits them, make partial payments, or even choose not to repay the loan at all. However, exercising this flexibility carries implications for the policy. Any outstanding loan balance, including accrued interest, will reduce the death benefit paid to beneficiaries upon the policyholder’s passing.

Furthermore, an outstanding loan can affect the policy’s future cash value growth. The portion of the cash value used as collateral for the loan may not continue to earn interest or dividends at the same rate as the unencumbered portion. This can slow the overall growth of the policy’s cash value, potentially impacting its long-term financial performance.

A risk associated with life insurance policy loans is the potential for policy lapse. If the outstanding loan balance, including capitalized interest, grows to exceed the policy’s cash value, the policy can terminate. Such a lapse can lead to adverse tax consequences for the policyholder. If a policy lapses with an outstanding loan, the amount of the loan that exceeds the total premiums paid into the policy may be considered taxable income. This taxable amount typically represents the gains accumulated within the policy above the amount of premiums paid, and it can result in an unexpected tax bill.