How Much Can You Borrow From Your Life Insurance Policy?

Life insurance policies offer financial protection for beneficiaries after the policyholder’s death. Beyond this primary purpose, certain types of policies can also serve as a source of funds during the policyholder’s lifetime. This is possible through the accumulation of cash value, which can be accessed via a policy loan, using the policy itself as collateral.

Policy Eligibility for Loans

The ability to borrow from a life insurance policy depends on whether it has a cash value component. Permanent life insurance policies, such as whole life, universal life, and variable universal life, accumulate cash value over time. A portion of each premium payment goes towards the cost of insurance, while another part is allocated to a cash account that grows on a tax-deferred basis.

In contrast, term life insurance policies do not build cash value because they provide coverage for a specific period without an investment or savings component. Consequently, term life insurance policies do not allow for policy loans. Cash value accumulation typically takes several years from the policy’s inception, with the exact timeframe varying by policy type and insurer.

Calculating Available Loan Amount

The maximum amount a policyholder can borrow is determined by the accumulated cash surrender value of the policy, not the death benefit. Insurers typically allow policyholders to borrow a percentage of this value, often ranging from 90% to 95% of the cash surrender value. The cash surrender value represents the policy’s cash value minus any potential surrender charges or outstanding loans.

The actual cash value available for a loan is influenced by several factors, including the total premiums paid into the policy, the policy’s duration, and the performance of the underlying investments in some policy types. Any existing outstanding loans against the policy will also reduce the amount available for new borrowing.

The Loan Process and Interest

Initiating a life insurance policy loan is a straightforward process, as it does not involve credit checks or a formal loan application. Policyholders can request a loan by contacting their insurance company directly, either through a phone call, online portal, or by submitting a specific form. Funds are typically disbursed within a few business days once the request is processed.

Policy loans accrue interest from the date the funds are disbursed. The interest rate can be either fixed or variable, depending on the policy’s terms and the insurer. Interest rates on life insurance policy loans range from approximately 5% to 8%, which can often be more competitive than rates for unsecured personal loans. While there is no set repayment schedule for policy loans, interest continues to accumulate on the outstanding balance.

Effects of Outstanding Policy Loans

If the policyholder passes away before fully repaying the loan, the death benefit paid to beneficiaries will be reduced by the outstanding loan amount plus any accrued interest. If the outstanding loan balance, including accrued interest, grows to exceed the policy’s cash value, the policy can lapse. A policy lapse means coverage terminates, leaving the policyholder without life insurance protection. If a policy lapses with an outstanding loan, the loan amount that exceeds the policyholder’s basis (premiums paid) may be considered taxable income by the Internal Revenue Service (IRS), potentially resulting in an unexpected tax liability.