What Type of Life Insurance Can I Borrow From?

Life insurance primarily provides a financial safety net for beneficiaries upon the insured’s death. Beyond this, certain policies offer living benefits, allowing policyholders to access accumulated funds while alive. One such benefit is the ability to borrow money directly from the policy. This feature provides a flexible financial resource, distinguishing these policies from those designed solely for a death benefit.

Life Insurance Policies with Borrowing Capability

Not all life insurance policies allow borrowing; this feature is tied to policies that accumulate cash value. Life insurance generally falls into two main categories: term life insurance and permanent life insurance.

Permanent life insurance policies provide coverage for the insured’s entire lifetime, as long as premiums are paid. These policies include a savings component that accumulates cash value, which policyholders can access. Whole Life Insurance is a common type of permanent life insurance, featuring a guaranteed cash value accumulation rate and a level premium. The cash value in a whole life policy grows predictably, making it a reliable source for policy loans.

Universal Life Insurance is another type of permanent life insurance, offering more flexibility in premium payments and death benefits than whole life. Its cash value accumulates based on an interest rate, which can vary. This accumulation allows policyholders to borrow against the cash value, similar to whole life policies. Sub-types like Indexed Universal Life (IUL) and Variable Universal Life (VUL) also build cash value, linked to market indices or investment sub-accounts, respectively. These policies also permit borrowing against the accumulated cash value.

In contrast, Term Life Insurance provides coverage for a specific period, such as 10, 20, or 30 years. Term life policies are generally less expensive than permanent policies because they do not include a cash value component. Since term life insurance does not build cash value, policyholders cannot borrow against it.

The Foundation of Policy Loans: Cash Value

The ability to borrow from a life insurance policy is directly linked to its cash value. Cash value is a savings component that accumulates within certain permanent life insurance policies over time. It represents a portion of premium payments, along with any accrued interest or investment gains, that grows within the policy. This accumulated cash value serves as the asset that makes policy loans possible.

When a policyholder takes a loan, they are not directly withdrawing money from the cash value in a way that permanently reduces it. Instead, a policy loan is an advance from the insurance company, with the policy’s cash value acting as collateral. The cash value continues to remain within the policy and can grow, even while a loan is outstanding. This structure ensures the policy remains intact and continues to provide its intended benefits.

Cash value accrues gradually from a portion of the premiums paid. For instance, in a whole life policy, a guaranteed interest rate contributes to its steady growth. In universal life policies, growth might be tied to declared interest rates or market performance. This accumulation provides a liquid asset that the policyholder can access without surrendering the policy or making a permanent withdrawal.

How to Borrow from Your Life Insurance Policy

Borrowing from a life insurance policy leverages the accumulated cash value as collateral. Unlike traditional loans, a policy loan is an advance from the insurance company itself, not a third-party lender. The policyholder is essentially borrowing their own money, secured by the policy’s cash value.

To initiate a policy loan, the policyholder contacts their insurance provider. The insurer will provide the necessary forms and instructions. Processing time for a policy loan is generally efficient, often ranging from a few business days to about one week, depending on the insurer and policy terms.

The amount that can be borrowed is usually limited to a percentage of the available cash value, commonly 90% to 95% of the accumulated amount. For example, if a policy has $10,000 in cash value, a policyholder might borrow up to $9,000 or $9,500. While the loan is outstanding, the policy’s cash value typically continues to grow, though the loan itself will accrue interest.

Policy loans do not require credit checks, as the loan is secured by the policy’s cash value. There is generally no strict repayment schedule mandated by the insurer, providing policyholders with flexibility in how and when they repay the funds.

Managing and Understanding Policy Loans

Managing an outstanding policy loan involves understanding its financial implications, including interest accrual, repayment flexibility, and impact on benefits. Policy loans accrue interest, typically charged annually. The interest rate can vary, but for fixed-rate policy loans, it often falls within 5% to 8% per year. This accrued interest can either be paid out-of-pocket or capitalized, meaning it is added to the outstanding loan balance.

Policy loans have a flexible repayment schedule. Unlike traditional loans, there are generally no mandatory monthly payments or fixed repayment terms. Policyholders can choose to repay the loan at their own pace, or not at all. This flexibility can be advantageous during financial strain.

An outstanding loan balance, including any accrued and unpaid interest, directly reduces the death benefit paid to beneficiaries. For example, if a policy has a $500,000 death benefit and a $50,000 outstanding loan, beneficiaries would receive $450,000.

A risk with policy loans is the potential for policy lapse. If the outstanding loan balance, combined with accrued interest, grows to exceed the policy’s available cash value, the policy can terminate. This typically occurs if no interest payments are made and the loan continues to grow. If a policy lapses with an outstanding loan, the amount of the loan exceeding premiums paid can become taxable income. As long as the policy remains in force, policy loans are generally considered tax-free transactions. To prevent lapse, policyholders should continue paying regular premiums and manage their loan balance responsibly.