How to Borrow From Your Life Insurance

Life insurance loans offer a way to access funds that have accumulated within a policy. This financial tool allows policyholders to leverage the cash value component of their life insurance, providing a source of liquidity without needing to apply for traditional loans. Understanding how these loans function is important for anyone considering this option.

Life Insurance Policies That Allow Loans

Certain life insurance policies build a cash value over time, which is a portion of the premium payments that grows on a tax-deferred basis. This cash value component is fundamental for securing a life insurance loan. Cash value represents an accumulating fund within the policy that can be accessed during the policyholder’s lifetime.

Policies that accumulate cash value are permanent life insurance, including whole life, universal life, variable universal life, and indexed universal life. For instance, whole life policies offer a fixed interest rate for cash value growth, while universal life policies may have market-dependent growth rates, often with a guaranteed minimum. Indexed universal life policies tie growth to market indices for potential higher returns.

In contrast, term life insurance policies do not build cash value. These policies provide coverage for a specific period, such as 10, 20, or 30 years, and typically do not have a savings component. Consequently, term life insurance policies do not offer the option to borrow against them, as there is no cash value to serve as collateral for a loan. It often takes several years, typically two to ten, for a policy’s cash value to grow sufficiently to support a loan.

How Life Insurance Loans Operate

When a policyholder takes a loan against their life insurance, they are borrowing money from the insurance company, using the policy’s cash value as collateral. This is not a withdrawal of funds from the policy itself; instead, the cash value remains intact and continues to grow, serving as security for the loan. The loan amount is usually limited, with many insurers allowing borrowing up to 90% of the total cash value.

Interest accrues on the outstanding loan balance, similar to other types of loans. Interest rates for life insurance loans can be fixed or variable, ranging between 5% and 8%. If interest payments are not made, the unpaid interest is added to the loan principal, increasing the overall loan balance.

Life insurance loans offer flexibility in repayment; there is generally no strict repayment schedule or due date. Policyholders can choose to repay the loan in full, make periodic payments, or pay only the interest, though repayment is not strictly mandated. Any outstanding loan balance, including accrued interest, will reduce the death benefit paid to beneficiaries if the policyholder passes away before repayment.

A policy may lapse if the loan balance, along with accrued interest, grows to exceed the policy’s cash value. If this occurs, the insurance company may terminate the policy, leading to loss of coverage. If a policy lapses with an outstanding loan, the unpaid loan amount that exceeds the premiums paid into the policy may be considered taxable income by the IRS. Loans from a life insurance policy are generally not considered taxable income as long as the policy remains in force and is not classified as a Modified Endowment Contract (MEC). A MEC is a policy that has received too much premium too quickly, which changes the tax treatment of loans and withdrawals.

Process for Securing a Life Insurance Loan

Securing a loan against a life insurance policy typically involves a straightforward process, as it does not usually require a credit check or a formal approval process. The policyholder borrows against their own accumulated cash value, which serves as collateral. The primary requirement is that the policy has built up sufficient cash value to support the desired loan amount.

To initiate the process, policyholders contact their insurance company directly. This can be done through various channels, such as calling a customer service representative, accessing an online policy portal, or contacting their insurance agent. The insurer will confirm the available loan amount based on the policy’s current cash value.

When requesting the loan, specific information will be required to complete the transaction. This typically includes the policy number, the exact loan amount desired, and details for the recipient bank account for direct deposit of funds. Some insurers may also request a voided check or an Electronic Funds Transfer (EFT) form to ensure accurate transfer of funds.

After submitting the loan request, policyholders can expect a processing period. While there is no lengthy approval process, it typically takes a few business days to a week for the funds to be disbursed. The insurance company will usually provide confirmation of the loan approval and details regarding the deposit of funds once the request is processed. It is important for the policyholder to review the loan agreement or terms provided by the insurer, which will outline the interest rate, repayment options, and any specific conditions related to the loan.