What Type of Life Insurance Can You Borrow From?

Policies with Borrowing Capability

Life insurance policies with a cash value component allow policyholders to access funds through policy loans. Unlike term life insurance, permanent life insurance policies build an accessible cash reserve over time. The ability to borrow against a life insurance policy depends entirely on the presence and growth of this cash value.

Whole life insurance is a permanent policy that builds cash value on a guaranteed basis. Premiums remain fixed, and a portion of each payment contributes to the cash value, which grows at a declared interest rate. This guaranteed growth provides a reliable source for potential policy loans once sufficient cash value has accumulated.

Universal life insurance offers more flexibility than whole life, allowing policyholders to adjust premiums and death benefits. Cash value accumulation depends on premiums paid and deducted costs. The cash value grows based on an interest rate declared by the insurer, which can fluctuate but often has a minimum guarantee. This flexibility means cash value growth can vary, influencing the amount available for a loan.

Variable universal life insurance combines universal life’s flexibility with investment opportunities. Policyholders can allocate premiums to various investment sub-accounts, such as stocks, bonds, or money market funds. Cash value growth is directly tied to investment performance, offering potential for higher returns but also carrying risk. The cash value, and thus the loanable amount, can fluctuate significantly, reflecting market performance.

Mechanism of a Life Insurance Loan

A loan from a life insurance policy differs from a traditional bank loan, as it involves borrowing from the insurer using the policy’s accumulated cash value as security. The policyholder borrows from the insurer’s general account, with the cash value acting as collateral. This arrangement means the loan does not deplete the cash value directly but creates a lien against it. The policy remains intact, and its cash value continues to grow, albeit with a portion encumbered by the loan.

The policy’s cash value serves as the sole collateral for the loan, eliminating the need for a credit check or extensive financial underwriting. This makes policy loans accessible. The loan amount is limited to a percentage of the cash surrender value, often up to 90% or 95%. Since the loan is secured by the policy’s assets, the approval process is straightforward and quick, taking just a few business days.

Interest accrues on the outstanding loan balance, with the rate set by the insurer. While interest is charged, it is not paid to a third-party lender; instead, it is added back to the loan balance if not paid, or paid to the insurer. Some policies allow interest to be paid annually, while others permit it to accumulate and be deducted from the death benefit or cash value if the policy lapses. Accumulating interest can reduce the cash value available for future growth or withdrawals.

An outstanding policy loan, including accrued interest, reduces the death benefit paid to beneficiaries. For example, if a policy has a $500,000 death benefit and an outstanding loan of $50,000, beneficiaries would receive $450,000. Policy loans are not considered taxable income as long as the policy remains in force and the loan is not surrendered for cash. If the policy lapses or is surrendered with an outstanding loan, and the loan amount exceeds the premiums paid, the difference may become taxable income.

Applying for and Managing a Policy Loan

Before initiating a life insurance policy loan, policyholders should review their policy’s specific terms and conditions. This includes understanding the interest rate charged on loans, which can be fixed or variable, and any administrative fees. It is important to determine the exact amount of cash value available for a loan, as insurers allow borrowing up to a certain percentage of the cash surrender value. Evaluating the loan’s potential impact on the policy’s long-term performance and the death benefit is a preparatory step.

Applying for a policy loan involves contacting the life insurance company directly. Policyholders complete a loan request form, providing the desired loan amount and preferred disbursement method. Funds can be disbursed via direct deposit or by check, usually within a few business days. Insurers provide instructions and support to guide policyholders through this process.

Managing a policy loan offers flexibility, as there is no fixed repayment schedule. Policyholders can choose to repay the loan in full, make partial payments, or not repay it at all. Interest on the loan will continue to accrue as long as there is an outstanding balance. While there is no obligation to repay, regular interest payments can help prevent the loan balance from growing excessively and reducing the policy’s value.

Failure to repay a policy loan, especially if the outstanding loan balance plus accrued interest approaches or exceeds the policy’s cash value, carries consequences. If the loan balance surpasses the cash value, the policy may lapse, meaning coverage terminates. Any outstanding loan amount exceeding premiums paid can become taxable income. Even if the policy does not lapse, an unpaid loan will permanently reduce the death benefit paid to beneficiaries, impacting the financial legacy.