How Long Before You Can Borrow From a Life Insurance Policy?

Life insurance policies can serve as a financial resource during your lifetime, extending beyond their primary function of providing a death benefit. Certain types of policies allow for the accumulation of a cash value, which policyholders can access through loans. This borrowing option is tied to the growth of this cash value, offering a flexible way to obtain funds. Understanding how cash value accumulates and the loan process is important for those considering this strategy.

Understanding Policy Cash Value

Cash value in a life insurance policy represents a savings component that accumulates over time, separate from the death benefit. A portion of each premium payment contributes to this cash value, which then grows on a tax-deferred basis through guaranteed interest rates, dividends, or market-linked returns, depending on the policy type. Permanent life insurance policies, such as whole life, universal life, variable universal life, and indexed universal life, are designed to build cash value. Term life insurance, conversely, does not include a cash value component and therefore cannot be borrowed against.

Eligibility for Policy Loans

The ability to borrow from a life insurance policy depends on the accumulation of sufficient cash value within that policy. There is no universal waiting period; eligibility arises once the cash value reaches a certain level, which varies by insurer and policy specifics. While some policies may begin to show minimal cash value within the first two to five years, a substantial amount often takes five to ten years or even longer to build. During the initial years, a significant portion of premiums typically covers policy fees and the cost of insurance, which slows cash value growth. The maximum amount generally available for a loan is typically up to 90% of the policy’s accumulated cash value.

The Loan Process and Terms

Once a life insurance policy has accumulated sufficient cash value, initiating a loan is generally a straightforward process. Policyholders typically contact their insurance provider directly to request the loan. An advantage is that these loans do not require a credit check, income verification, or approval, as the policy’s cash value serves as collateral. Interest rates on life insurance policy loans are generally competitive, often ranging from 5% to 9%, and can be either fixed or variable depending on the policy terms. The loan is taken against the policy’s cash value, and the cash value continues to accrue interest or dividends as if no loan had been taken, although the outstanding loan balance reduces the death benefit.

Loan Repayment and Consequences

Policy loans offer considerable flexibility regarding repayment, as there is typically no fixed schedule. Policyholders can choose to repay the loan, pay only the interest, or not repay it at all. However, interest accrues on the outstanding loan balance. If not paid, interest can be added to the principal, causing the loan amount to grow. If the loan, including accrued interest, is not repaid before the policyholder’s death, the outstanding balance will be deducted directly from the death benefit paid to beneficiaries.

A significant risk arises if the outstanding loan balance, along with accumulated interest, grows to exceed the policy’s cash value. In such cases, the policy can lapse, leading to loss of coverage. If a policy lapses with an outstanding loan, the amount exceeding the policy’s basis (premiums paid minus any dividends received) may become taxable as ordinary income, creating an unexpected tax liability. Policy loan interest is not tax deductible.