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

Life insurance policies can be used to obtain a loan, offering policyholders a way to access funds that have accumulated within the policy. This option is available with specific types of life insurance.

Understanding Policy Loan Eligibility

Policy loans are available through life insurance policies that accumulate cash value. These include permanent life insurance types such as whole life, universal life, variable universal life, and indexed universal life policies. A portion of the premiums paid into these policies is allocated to a cash value component, which grows over time on a tax-deferred basis.

Cash value represents a savings component within the policy that can be accessed during the policyholder’s lifetime. In contrast, term life insurance policies do not build cash value and therefore do not offer the option of a policy loan. It typically takes several years for sufficient cash value to accrue before a loan can be taken.

Mechanism of a Life Insurance Policy Loan

A life insurance policy loan differs from a traditional loan obtained from a bank or other external lender. Instead of borrowing from an outside institution, the policyholder is accessing funds from the insurance company, with the policy’s own cash value serving as collateral. The cash value does not physically leave the policy; rather, the insurance company lends money from its general account, placing a lien against the policy’s cash value.

Interest rates are applied to policy loans, which can be either fixed or variable, depending on the policy’s terms. This interest accrues on the outstanding loan balance. Unlike conventional loans, policy loans offer considerable flexibility regarding repayment; there is no mandatory repayment schedule or fixed due date.

Policyholders can choose to repay the loan in a lump sum, make partial payments, or even pay only the interest. Any unpaid interest is added to the outstanding loan balance, causing it to grow. Despite the loan, the policy’s cash value generally continues to earn interest or dividends.

Consequences of a Policy Loan

An outstanding policy loan can directly impact the life insurance policy, particularly if not managed effectively. The most immediate consequence is a reduction in the death benefit paid to beneficiaries. Any outstanding loan balance, along with accrued unpaid interest, will be deducted from the death benefit upon the insured’s death.

An unmanaged or growing loan balance can lead to policy lapse. If the outstanding loan and accrued interest grow to a point where they exceed the policy’s cash value, the policy can terminate. This situation leaves the policyholder without coverage.

A policy lapse or surrender with an outstanding loan can also trigger adverse tax implications. If the policy terminates and the loan balance exceeds the amount of premiums paid into the policy (the policy’s basis), the difference may be treated as taxable income. A large outstanding loan can reduce the cash value available for future growth.

Requesting and Managing a Policy Loan

Initiating a life insurance policy loan typically involves a straightforward process, as the policy’s cash value serves as collateral, eliminating the need for credit checks or complex approval procedures. The first step is usually contacting the insurance provider directly. Many insurers allow policyholders to check their available cash value and maximum loan amount online.

To formally request the loan, policyholders often need to complete specific forms provided by the insurer. Typical information includes the policy number and the desired loan amount. Once the request is processed, the loan funds are usually disbursed.

Managing the policy loan involves understanding its flexible repayment options. There is no fixed repayment schedule, allowing policyholders to make payments at their convenience. It is important to monitor the loan balance and accrued interest regularly to prevent the loan from eroding the policy’s cash value and potentially causing a lapse.