Can You Take a Loan Out on Term Life Insurance?

Life insurance provides financial protection by offering a death benefit to beneficiaries upon the policyholder’s passing. Many individuals seek to understand if their life insurance policy can also serve as a source of funds during their lifetime, specifically whether they can take out a loan against it. This article addresses loan eligibility against life insurance policies, differentiating between various types of coverage.

Term Life Insurance and Loan Eligibility

Term life insurance provides coverage for a specific period, such as 10, 20, or 30 years, offering a death benefit if the insured passes away within that defined term. Its primary function is to provide financial protection for a temporary need, like covering a mortgage or providing for dependents during their formative years. Once the term expires, the coverage typically ends, unless the policy is renewed or converted.

Term life insurance lacks a cash value component. This means premiums paid primarily cover the cost of the death benefit for the specified period. Consequently, policyholders cannot take out a loan against it.

Permanent Life Insurance and Cash Value Access

In contrast to term life, permanent life insurance policies, such as whole life or universal life, offer coverage for the policyholder’s entire life, provided premiums are paid. These policies accumulate cash value over time. This cash value grows on a tax-deferred basis, separate from the death benefit.

The cash value is a savings or investment element within the policy, accumulating as a portion of each premium payment is allocated to it. It typically grows at a guaranteed rate or based on market performance, depending on the policy type. This accumulated cash value is the asset against which policyholders can borrow. Therefore, individuals holding permanent life insurance policies have the option to access funds through a policy loan.

Mechanics of Life Insurance Policy Loans

When a policyholder takes a loan against their permanent life insurance, they are essentially borrowing from the accumulated cash value of their own policy. The insurer uses the policy’s cash value as collateral for the loan. Policy loans typically do not require a credit check, and the repayment schedule can be highly flexible.

Interest accrues on the loan, with rates typically ranging from 4% to 8%, and these rates can be fixed or variable depending on the policy terms. While repayment of the loan is often optional, any outstanding loan balance, including accrued interest, will reduce the death benefit paid to beneficiaries. For instance, if a policy has a $200,000 death benefit and a $20,000 outstanding loan, the beneficiaries would receive $180,000. Additionally, if the policy is surrendered or lapses with an outstanding loan, the loan amount exceeding the basis (premiums paid) could become taxable income.

Alternative Financial Considerations

For individuals who possess only term life insurance and find themselves in need of funds, other financial avenues exist. Personal loans from banks or credit unions can be an option, often based on an individual’s creditworthiness and income. These loans typically come with fixed repayment terms and interest rates.

Another consideration might be to explore home equity loans or lines of credit if one owns a home and has sufficient equity. These options leverage the value of real estate as collateral. Alternatively, individuals might consider utilizing existing savings, exploring options to borrow from retirement accounts like a 401(k), or using credit cards, though the latter often carries higher interest rates.