How Can You Borrow From Your Life Insurance?

A life insurance loan provides a way to access funds by borrowing against the accumulated cash value within a permanent life insurance policy. This financial tool allows policyholders to obtain money without traditional lending processes, such as credit checks or extensive approval procedures, as the policy’s cash value serves as collateral. This approach offers a flexible alternative for those seeking liquidity, keeping the life insurance policy active as long as premium payments are maintained.

Policies That Qualify for Loans

Only specific types of life insurance policies are eligible for loans due to their inherent structure. Permanent life insurance policies, such as whole life, universal life, and variable universal life, include a cash value component that grows over time. This cash value represents a savings portion of the policy, accumulating as premiums are paid and interest or investment returns are credited. The ability to borrow stems directly from this cash accumulation.

Term life insurance policies do not qualify for loans because they lack a cash value component. These policies provide coverage for a defined period, focusing solely on the death benefit. For policies that do accumulate cash value, the loan amount is limited by the available cash value, with many insurers allowing borrowing up to 90% of the total cash value. It can take several years for a policy’s cash value to grow sufficiently for a meaningful loan, often requiring two to five years to begin accumulating and potentially ten years or more to reach a substantial amount.

The Loan Process

Obtaining a loan from a qualifying life insurance policy is a straightforward process, distinct from applying for a bank loan. Policyholders initiate a loan request by contacting their insurance provider directly, through a phone call, an online portal, or by submitting a written request via mail. Since the policy’s cash value acts as collateral, a formal credit check or a lengthy approval process is not required. The policyholder indicates the desired loan amount, which must be within the available cash value limits, and provides necessary policy identification details.

Once the request is submitted, the insurance company processes the loan, setting the applicable interest rate and creating the loan agreement. Funds can be disbursed through various methods, such as direct deposit into a bank account or by check. The timeline for receiving funds can vary, with some insurers processing requests within a few business days, while others may take up to several weeks. This simplified procedure allows for quick access to funds without the hurdles of traditional lending.

Financial Considerations of a Life Insurance Loan

Once a life insurance loan is taken, several financial implications arise that policyholders must understand. Interest accrues on the outstanding loan balance, and while rates are lower than those for personal loans or credit cards, they can be fixed or variable depending on the policy’s terms. This interest is added directly to the loan balance if not paid, causing the total amount owed to increase over time through compounding.

A notable aspect of life insurance loans is their flexible repayment structure; there is no mandatory repayment schedule or fixed due dates. Policyholders can choose to repay the principal and interest at their discretion, or even make interest-only payments. However, any outstanding loan balance, including accrued interest, will directly reduce the death benefit paid to beneficiaries upon the policyholder’s passing.

Failing to manage the loan can lead to policy lapse if the loan balance, along with accumulated interest, grows to exceed the policy’s cash value, potentially causing the insurer to terminate the policy. A policy lapse results in the loss of insurance coverage and can also trigger adverse tax consequences. While life insurance loans are not considered taxable income as long as the policy remains in force, a lapse or surrender with an outstanding loan can change this. Any amount received from the policy, including the loan, that exceeds the policy’s basis (the total premiums paid less any tax-free distributions) may then become taxable as ordinary income. For policies classified as Modified Endowment Contracts (MECs), specific tax rules apply, treating loans and withdrawals as taxable income on a “Last-In, First-Out” (LIFO) basis, meaning gains are taxed first; additionally, if the policyholder is under age 59½, a 10% penalty may apply to the taxable amount from a MEC.