How to Borrow Money From Life Insurance Policy
Unlock the value within your life insurance policy. Understand how to borrow against its cash value, navigate the process, and manage the loan effectively.
Obtaining funds from a life insurance policy can serve as a flexible financial option for policyholders. This process involves borrowing against the accumulated value within certain types of life insurance, rather than applying for a traditional loan from a bank or other lending institution. It provides a way to access cash that has grown within the policy, often without the stringent requirements of conventional loans.
Policy Eligibility and Loan Mechanics
Not all life insurance policies are eligible for loans; this option is exclusively available with permanent life insurance policies that build cash value. These include whole life, universal life, variable universal life, and indexed universal life policies. Term life insurance policies do not accumulate cash value and therefore cannot be used for policy loans.
The loan is taken directly from the insurance company, but it is secured by the policy’s cash value, which acts as collateral. This cash value grows over time as a portion of each premium payment is allocated to it. Policies typically accumulate enough value to borrow against after two to five years, though it might take longer for a substantial amount to accrue.
The maximum amount a policyholder can borrow is usually a percentage of the accumulated cash value, commonly up to 90%. For instance, if a policy has $10,000 in cash value, a policyholder might be able to borrow up to $9,000. The specific limit can vary by insurer and policy terms.
Interest is charged on the outstanding loan balance, with rates typically ranging from 5% to 8%. These rates can be fixed or variable, depending on the policy’s terms. Although interest accrues, policy loans generally offer significant flexibility regarding repayment. Unlike conventional loans, there is often no mandatory repayment schedule, allowing policyholders to repay the loan at their discretion, or even not at all during their lifetime.
Taking a loan can affect the policy’s growth and potential dividend payments. In some whole life policies, the portion of cash value used as collateral for the loan may earn a different dividend rate, or no dividend. This depends on the insurer’s “direct recognition” or “non-direct recognition” approach, which impacts how loaned values affect dividends. This distinction can impact the overall growth of the policy’s cash value.
The Loan Application Process
Initiating a life insurance policy loan typically begins by contacting the insurance provider. Policyholders can reach out to customer service, access an online portal, or consult with their agent. This initial contact helps determine the available cash value and the maximum loan amount accessible from the policy.
To process the loan request, the insurer generally requires specific information from the policyholder. This usually includes the policy number, the desired loan amount, and personal identification. For direct deposit, bank account details, such as routing and account numbers, may also be necessary.
A loan request form often needs to be completed. This form can usually be downloaded from the insurer’s website or requested by mail. Accurately fill out all required fields on the form to avoid delays in processing.
Once the form is completed, it can be submitted through various methods, including online via the insurer’s portal, mail, or sometimes fax. The submission method may depend on the insurer’s capabilities and the policyholder’s preference.
The processing time for a life insurance policy loan is generally efficient compared to traditional loans, as no credit checks or extensive underwriting are typically involved. After submitting the application, it can take anywhere from a few days to a couple of weeks for the loan to be processed and for the funds to be disbursed. Funds are often sent via direct deposit or a check, depending on the policyholder’s choice and the insurer’s available options.
Managing Your Policy Loan
After obtaining a life insurance policy loan, policyholders have various options for repayment. While there is often no strict repayment schedule, loans can be repaid in a lump sum, through partial payments, or by making regular contributions. This flexibility means policyholders can tailor repayment to their financial situation, though interest continues to accrue on the outstanding balance.
Interest on the loan accumulates over time, and if not paid, it is typically added to the outstanding loan balance. This compounding of interest can cause the loan amount to grow significantly if left unaddressed. It is advisable to at least pay the accruing interest to prevent the loan balance from increasing and potentially impacting the policy’s integrity.
Unpaid loans have direct consequences for the life insurance policy. Upon the policyholder’s death, any outstanding loan balance, including accrued interest, will be subtracted from the death benefit paid to beneficiaries. This reduction can significantly diminish the financial protection intended for loved ones.
A more severe consequence arises if the outstanding loan balance, combined with accrued interest, grows to exceed the policy’s cash value. In such cases, the policy may lapse, meaning the coverage terminates. This can lead to a complete loss of life insurance coverage.
Furthermore, if a policy lapses with an outstanding loan, there can be significant tax implications. The amount of the loan that exceeds the premiums paid into the policy can become taxable income to the policyholder, categorized as cancellation of indebtedness income. The insurer may issue a Form 1099-R for this amount, requiring the policyholder to report it as ordinary income.