How Much Can I Borrow From My Life Insurance?

Navigating personal finance often involves exploring various avenues for accessing funds. For some, a life insurance policy can offer a unique solution. Certain types of life insurance policies are designed with a feature that allows policyholders to borrow against their accumulated value. This article provides guidance on understanding how these policy loans function and the considerations involved.

Policy Eligibility and Cash Value

The ability to borrow from a life insurance policy hinges on the type of policy held, specifically permanent life insurance policies. These include whole life, universal life, and variable universal life, all of which build a cash value component over time. Term life insurance, by contrast, does not accumulate cash value and therefore cannot be borrowed against.

The cash value within a permanent life insurance policy is a savings component that grows on a tax-deferred basis. This accumulated cash value serves as collateral for any loan taken from the policy. When a loan is obtained, it is taken against this cash value, not as a direct withdrawal from it, meaning the policy generally remains in force.

Calculating Your Available Loan Amount

The amount available for a policy loan is directly linked to the accumulated cash value within the policy. Insurers typically allow borrowing up to a certain percentage, commonly ranging from 90% to 95% of the total cash value. For example, if a policy has $50,000 in cash value, a policyholder might be able to borrow up to $45,000 or $47,500. Any existing outstanding loans against the policy, including accrued interest, will reduce the amount that can be borrowed.

If the insured individual passes away before a policy loan is fully repaid, the outstanding loan balance, along with any accrued interest, will be deducted from the death benefit paid to beneficiaries. Newer policies may take several years, typically two to ten, to build sufficient cash value for a meaningful loan.

Steps to Obtain a Policy Loan

Initiating a policy loan typically involves contacting the insurance company directly, often through a customer service representative or a dedicated policyholder portal. Many insurers offer online access where policy values and maximum loan availability can be checked. This direct contact streamlines the process, as there is no extensive approval process or credit check required since the loan is secured by the policy’s own cash value.

The information usually required for a loan request includes the policy number and the desired loan amount. Once the request is submitted and any necessary forms are processed, funds are typically disbursed via direct deposit or check. The processing time for a policy loan can vary but generally takes approximately five to ten business days from the receipt of the request and paperwork.

Understanding Loan Repayment

Policy loans differ from conventional loans because they generally do not come with a fixed repayment schedule or mandatory monthly payments. Policyholders have the flexibility to repay the loan at their discretion, whether through a lump sum, periodic payments, or even by choosing not to repay the principal at all. Interest does accrue on the outstanding loan balance, and this interest rate is set by the insurer, which can be either fixed or variable.

Unpaid interest is typically added to the loan’s principal, which increases the total outstanding loan balance over time. If the loan balance, including accrued interest, grows to exceed the policy’s cash value, the policy may lapse or terminate. Such a lapse can have significant tax implications, as any outstanding loan amount that exceeds the premiums paid into the policy can be treated as taxable income by the IRS. Understanding these mechanics is important for maintaining the policy’s benefits and avoiding unintended tax consequences.