What Is a Life Insurance Policy You Can Borrow Against?

Life insurance policies that allow policyholders to borrow money offer a unique financial tool. This feature is tied to a component within certain types of policies known as cash value. As premiums are paid, a portion accumulates as cash value, which can then be accessed by the policyholder. This accumulated value serves as the basis for a policy loan, providing a source of funds during the policyholder’s lifetime.

Policies with Cash Value

Life insurance policies that build cash value are permanent life insurance. Unlike term life, which covers a specific period, permanent policies are designed to last for the policyholder’s entire life. The cash value component acts as a savings or investment feature within the policy, increasing over time.

Whole life insurance is a type of permanent policy where cash value grows at a fixed rate, often guaranteed by the insurer. A portion of each premium payment is allocated to this account. The cash value can be accessed through loans, withdrawals, or by surrendering the policy.

Universal life insurance offers more flexibility than whole life, allowing policyholders to adjust premiums and death benefits within certain limits. Its cash value grows based on an interest rate set by the insurer. Indexed universal life insurance, a variation, ties cash value growth to a stock market index, with a floor and cap on returns.

Variable universal life (VUL) insurance offers potential for higher cash value growth, but also greater risk. With VUL, cash value is invested in subaccounts, similar to mutual funds, and its performance depends on chosen investments. Policyholders can choose their investment strategy. If investments perform poorly, the cash value and death benefit may decrease.

Understanding Policy Loans

A policy loan is an advance from the insurer, using the policy’s cash value as collateral. There is no credit check or extensive approval process, as the cash value secures the loan. The policyholder is borrowing their own money, with the cash value continuing to grow even while a loan is outstanding.

Interest accrues on policy loans, with rates often lower than personal loans or credit cards. The interest rate can be fixed or variable. Repayment offers flexibility; there is no strict schedule, and policyholders can choose to make periodic payments, pay interest only, or defer repayment indefinitely. If interest is not paid, it will be added to the loan balance, causing it to grow.

If a policy loan, including accrued interest, is not repaid, it reduces the death benefit paid to beneficiaries upon the policyholder’s passing. This reduction occurs dollar-for-dollar by the outstanding loan amount and any accumulated interest. If the loan and its accrued interest exceed the policy’s cash value, the policy can lapse. A policy lapse can have significant tax consequences, as any loan amount exceeding the cost basis (premiums paid) may become taxable income.

Policy loans differ from withdrawals from cash value. A withdrawal permanently removes funds, reducing both the cash value and the death benefit. Unlike a loan, a withdrawal does not accrue interest and is not repaid. Withdrawals exceeding the cost basis may be taxable. A policy loan is generally not considered taxable income as long as the policy remains in force.

Accessing a Policy Loan

Accessing a loan from a life insurance policy begins with contacting the insurance company. Policyholders can initiate a loan request. This step confirms the policy’s eligibility and the amount of cash value available for a loan.

The amount that can be borrowed is a substantial percentage of the policy’s accumulated cash value, often up to 90% or 95%. The exact limit is determined by the insurer and policy terms. There is no traditional loan application or credit check. The process is straightforward because the policy’s cash value serves as collateral for the loan.

Once the loan request is processed, the funds are disbursed to the policyholder. Processing time can vary. This quick access to funds can be beneficial for financial needs.

After the loan is disbursed, the policyholder receives ongoing statements detailing the loan balance and accrued interest. It is important to monitor these statements to understand the loan’s impact on the policy’s cash value and death benefit. Repayment is flexible, and oversight helps ensure the policy remains in good standing. Maintaining awareness helps prevent unintended consequences, such as a reduction in the death benefit or policy lapse.