Can You Take a Loan Out on Life Insurance?

A life insurance loan provides a way to access funds by borrowing against the accumulated value within a permanent life insurance policy. It is a financial transaction where the policyholder receives an advance from the insurer, using the policy’s cash value as collateral. This type of loan can offer a flexible alternative to traditional borrowing methods. However, the ability to borrow is directly tied to the policy’s cash value component, meaning not all life insurance policies are structured to allow for such loans.

Eligibility for a Life Insurance Loan

The ability to take a loan from a life insurance policy hinges on whether the policy has a cash value component. Only permanent life insurance policies, such as whole life, universal life, variable universal life, and indexed universal life, accumulate cash value over time. These policies differ from term life insurance, which provides coverage for a specific period and does not build any cash value, meaning term policies cannot be used for loans.

Cash value is a savings component that grows within a permanent life insurance policy, separate from the death benefit. A portion of each premium payment is allocated to this cash value account, where it can grow through guaranteed interest rates, dividends, or investment performance, depending on the policy type. It typically takes several years for sufficient cash value to accumulate before it can be accessed for a loan.

Mechanics of a Life Insurance Loan

A life insurance loan operates as an advance from the insurer, with the policy’s cash value securing the borrowed amount. The policy’s cash value remains intact and continues to grow, even with an outstanding loan. Policyholders can typically borrow up to a certain percentage of their policy’s current cash value, commonly ranging from 90% to 95%. For instance, a policy with $10,000 in cash value might allow a loan of up to $9,000.

The loan accrues interest, which is set by the insurer and can be either a fixed or variable rate, often ranging from 5% to 8%. There is generally no credit check or extensive approval process involved, as the policy’s cash value provides the security. The borrowed funds can be used for any purpose the policyholder chooses, offering significant financial flexibility.

Repayment and Policy Impact

Repaying a life insurance loan offers considerable flexibility, as there is typically no strict repayment schedule or mandatory payments. Policyholders can choose to repay the principal and interest at their own pace, pay only the interest, or even make no repayments at all. However, interest continues to accrue on the outstanding loan balance, and if left unpaid, it will increase the total amount owed.

An outstanding loan impacts the policy’s death benefit. If the loan, plus any accrued interest, is not repaid before the policyholder’s death, the outstanding amount is deducted directly from the death benefit paid to beneficiaries. This means beneficiaries will receive less than the policy’s original face amount.

A more severe risk arises if the outstanding loan balance, including accrued interest, grows to exceed the policy’s cash value. In such a scenario, the policy could lapse, meaning coverage terminates. If a policy lapses with an outstanding loan, the unpaid loan amount that exceeds the policyholder’s cost basis (premiums paid) may be considered taxable income by the IRS, potentially leading to an unexpected tax liability.

Applying for a Policy Loan

Initiating a life insurance policy loan typically begins by contacting the insurance company directly, either by phone or through their online portal. The policyholder will need to provide necessary policy information and specify the desired loan amount, up to the maximum allowed by the policy’s cash value. While some insurers may require a simple loan request form, a lengthy application is generally not part of the process.

Once the request is submitted, the processing time for a life insurance loan can vary, but funds are often received within a few days to a couple of weeks, typically around one week. Funds are usually disbursed via direct deposit to a designated bank account or by check. It is important to confirm the method of fund transfer and any associated processing times with the insurer.