How to Borrow Against Your Life Insurance Policy

Borrowing against a life insurance policy involves accessing funds from the policy’s accumulated cash value. This financial arrangement allows policyholders to receive a loan directly from their insurance company. It is distinct from securing a loan from a bank or other third-party lender. The money accessed through such a loan is essentially a portion of the policyholder’s own accumulated funds within the insurance contract.

Determining Eligibility

Only permanent life insurance policies, such as whole life and universal life, build cash value that can be borrowed against. Term life insurance policies do not accumulate cash value and therefore cannot be used for loans. A portion of each premium payment contributes to this cash value, which grows over time through interest or dividends, depending on the policy type.

Before a loan can be initiated, the policy must have accumulated sufficient cash value. The exact amount required varies by insurer, but it often takes several years, typically between two to ten years, for the cash value to reach a meaningful level for borrowing. Policyholders can typically borrow up to 90% of their policy’s accumulated cash value. To ascertain a policy’s eligibility and current cash value, reviewing the policy documents is advisable. Contacting the insurance provider directly, either through their customer service or online portal, can also provide specific details regarding loan availability and requirements.

Understanding Loan Terms

Life insurance policy loans accrue interest, which is determined by the insurer and can be either a fixed or variable rate. These rates typically range from 5% to 8%. The interest may be calculated and applied on a simple or compound basis, depending on the specific policy terms.

The policy’s cash value serves as collateral for the loan. This arrangement reduces the risk for the insurer, which is why credit checks are generally not required for these loans. An outstanding loan balance, along with any accrued interest, will directly reduce the death benefit paid to beneficiaries if the insured passes away before the loan is fully repaid. This means beneficiaries would receive a smaller payout.

Policy loans are generally not considered taxable income as long as the policy remains in force. Unlike traditional loans, policy loans typically do not have a mandatory repayment schedule. Interest continues to accrue, and managing the loan is important to prevent adverse effects on the policy.

The Borrowing Process

Initiating a policy loan typically begins by contacting the insurance provider directly. This can often be done through a phone call to their customer service, an online portal, or by submitting specific forms via mail. Insurers usually have a streamlined process for policy loans because the cash value serves as collateral, eliminating the need for extensive credit checks or lengthy underwriting.

When requesting a loan, the insurer will usually require basic information, such as the desired loan amount, the policy number, and personal identification details. Once the request is processed and approved, which can range from one day to a few weeks depending on the insurer and method, the funds are disbursed.

Funds are commonly received via direct deposit into a bank account or through a mailed check. The timeline for receiving the funds can vary, but many policyholders report a relatively quick turnaround compared to traditional loans.

Managing the Loan

After a policy loan is taken, policyholders have various options for repayment, including a lump sum, periodic payments, or even interest-only payments. While repayment is not strictly mandated by a fixed schedule, it is generally recommended to maintain the policy’s original value and death benefit. Tracking the outstanding loan balance and accrued interest is important, which can typically be done through statements from the insurer or their online platforms.

Failing to repay the loan can lead to significant consequences. If the accrued interest and outstanding loan balance eventually exceed the policy’s cash value, the policy can lapse. A policy lapse with an outstanding loan may trigger a taxable event, where the amount of the loan exceeding the premiums paid could become taxable income. This can result in an unexpected tax liability and the loss of coverage.

A policy loan differs from a withdrawal. A loan is money borrowed against the cash value that must be repaid to restore the full death benefit, whereas a withdrawal permanently reduces the cash value and can reduce the death benefit. Withdrawals may also be taxable if they exceed the premiums paid into the policy.