How to Borrow Against a Life Insurance Policy

Borrowing against a life insurance policy can provide access to funds. Instead of a lender evaluating credit history or income, the loan is secured by the accumulated cash value within the life insurance policy itself.

Understanding Life Insurance Policy Loans

A life insurance policy loan is not a withdrawal of funds from the policy’s cash value, but a loan taken from the insurance company, using the policy’s cash value as collateral. This means the cash value continues to accrue interest or investment gains even while a loan is outstanding. Only policies that build cash value allow for policy loans.

Term life insurance policies do not accumulate cash value. In contrast, permanent life insurance policies, such as whole life, universal life, and variable universal life, include a cash value component. This cash value grows over time through premium payments and investment growth, often on a tax-deferred basis.

Determining Your Loan Eligibility

Eligibility for a life insurance policy loan depends on the policy being in force and having accumulated sufficient cash value. Most insurance companies allow policyholders to borrow up to 85% to 90% of their policy’s cash value. For example, a policy with $50,000 in cash value might allow a loan of up to $45,000.

It can take several years for a policy to build enough cash value for a meaningful loan. While some policies may begin accruing cash value within two to five years, it could take 10 years or more for a substantial amount to accumulate. Unlike conventional loans, there is no credit check, employment verification, or minimum income requirement for a life insurance policy loan. The policy’s cash value itself acts as the collateral.

Applying for a Policy Loan

Once eligibility is confirmed and the policyholder understands the nature of the loan, the application process is generally straightforward. The first step involves contacting the life insurance company directly. This can often be done through various channels, including phone, their online portal, or by mail. Policyholders will typically need to provide their policy number and specify the desired loan amount.

The insurance company will then provide the necessary loan request forms. These forms require basic information, and instructions for completion are usually clear. After completing and signing the required documentation, the forms can be submitted according to the insurer’s guidelines, which might include online submission or mailing. Processing times are generally quick, with funds often disbursed within a few days via direct deposit or check. This streamlined process reflects that the loan is secured by the policy’s own value.

Managing Your Policy Loan

After a policy loan has been disbursed, managing it involves understanding its financial dynamics and potential impacts. Interest accrues on the outstanding loan balance, and this can be at either a fixed or variable rate, typically ranging from 5% to 8%. If the interest is not paid, it is often added to the principal loan balance, causing the total amount owed to increase over time.

Policy loans offer significant flexibility regarding repayment. There is usually no strict repayment schedule, allowing policyholders to make payments as they choose, including lump sums, regular smaller payments, or even no payments at all. However, any outstanding loan balance, including accrued interest, will reduce the death benefit paid to beneficiaries upon the insured’s death. This means beneficiaries will receive less than the policy’s face amount if the loan is not fully repaid.

A significant risk associated with policy loans is the potential for the policy to lapse. If the loan balance, along with accrued interest, grows to exceed the policy’s cash value, the insurance company may terminate the policy. This would result in the loss of coverage and any remaining cash value.

From a tax perspective, policy loans are generally not considered taxable income as long as the policy remains in force. However, if the policy lapses or is surrendered while a loan is outstanding, the loan amount can become taxable income to the extent it exceeds the premiums paid into the policy. Policies classified as Modified Endowment Contracts (MECs) have different tax rules, where loans are treated as taxable withdrawals first, and may incur a 10% penalty if the policyholder is under age 59½.