Can You Take a Loan Out on Your Life Insurance Policy?

Policyholders can access funds from certain life insurance policies through a policy loan. This financial tool allows borrowing against the accumulated cash value within their coverage. Understanding the mechanics and potential implications of such loans is important for those considering this option.

Understanding Life Insurance Policy Loans

A life insurance policy loan is an advance against the policy’s death benefit, secured by its accumulated cash value. Policy loans do not require a credit check, income verification, or an approval process. The interest rates for these loans are often lower than those for personal loans or credit cards.

Only specific types of life insurance policies accumulate cash value and thus allow for policy loans. These generally include permanent life insurance policies such as whole life, universal life, variable universal life, and indexed universal life. In contrast, term life insurance policies do not build cash value and therefore do not offer the option of a policy loan. The amount available for a loan is limited by the policy’s cash value, with most insurers typically allowing policyholders to borrow up to 90% to 95% of the accumulated amount.

How Life Insurance Policy Loans Work

Interest on a life insurance policy loan typically accrues daily and is billed annually to the policyholder. This interest can be either a fixed rate, which remains constant throughout the loan term, or a variable rate, which can fluctuate based on market conditions or benchmarks. If the interest is not paid, it is added to the loan principal, causing the outstanding balance to increase over time.

Policy loans offer considerable flexibility regarding repayment. There is typically no strict repayment schedule, meaning policyholders can choose to repay the loan partially, in full, or not at all during their lifetime. Any outstanding loan balance, including accrued interest, will directly reduce the death benefit paid to beneficiaries upon the insured’s passing.

The cash value within the policy continues to grow, potentially earning interest or dividends, even while a loan is outstanding. However, the portion of the cash value used as collateral for the loan is not available for further withdrawals or additional loans until the initial loan is repaid. For participating policies, outstanding loans might also influence the amount of future dividend payments.

Obtaining a Life Insurance Policy Loan

Before initiating a request, policyholders should determine the available loan amount, which is typically a percentage of the cash surrender value. It is also advisable to have the policy number and any required identification ready.

To apply for a loan, policyholders usually contact their insurance company directly. Requests can often be submitted through various channels, including online portals, by phone, or via mail using specific forms. Once the request is processed, funds are typically disbursed directly to the policyholder, often within a few days to approximately 15 days, via check or electronic transfer.

Impact of Life Insurance Policy Loans

If a loan, including its accrued interest, remains outstanding when the insured individual passes away, that amount is subtracted directly from the death benefit paid to the beneficiaries. This means the beneficiaries will receive a smaller payout than the original face amount of the policy.

A more severe outcome is the risk of policy lapse. If the outstanding loan balance, combined with accrued interest, grows to exceed the policy’s cash value, the insurance company may terminate the policy. Insurers typically provide notice before a lapse occurs, allowing the policyholder an opportunity to pay down the loan or the interest to prevent termination. If the policy lapses, coverage ceases, and the intended financial protection for beneficiaries is lost.

Furthermore, a policy lapse with an outstanding loan can trigger adverse tax implications. If the policy terminates, the amount of the loan that exceeds the premiums paid into the policy (known as the cost basis) can be considered taxable income to the policyholder. This unexpected tax liability can arise even if the policyholder does not receive any cash from the lapse. Additionally, an outstanding loan can impact the policy’s future growth, potentially slowing the accumulation of cash value or affecting dividend payments in certain policy types.