Thinking about tapping into your life insurance for extra cash? You’re not alone. Many people wonder about how to borrow from life insurance. This post explores if it’s possible, how it works, and if it’s the right move for you. It helps you make informed decisions about using your life policy.
Life insurance provides financial security for loved ones after your passing. But sometimes, you need money while you’re still living. This leads people to consider how to borrow from life insurance policies. Here you’ll learn whether borrowing against your life insurance is right for you.
Table of Contents:
- Understanding Life Insurance Loans
- Pros and Cons of Borrowing Against Life Insurance
- Alternatives to Borrowing From Life Insurance
- Borrowing Strategically: When It Makes Sense
- FAQs about how to borrow from life insurance
- Can you borrow money out of a life insurance policy?
- What is the cash value of a $10,000 life insurance policy?
- How long does it take to borrow money from life insurance?
- How to withdraw money from a life insurance policy?
- How is interest calculated on life insurance policy loans?
- What happens to my loan when I die?
- What are best practices for repaying life insurance loans?
- Can policy loans affect my cash value growth?
- Conclusion
Understanding Life Insurance Loans
Borrowing against your life insurance is called a “policy loan.” It’s only possible with a cash value life insurance plan. Unlike term life insurance, permanent life insurance policies like whole, universal, or variable universal life build cash value.
A portion of your premium goes towards coverage. The rest is invested and builds value, much like a savings account. Check our breakdown of life insurance policies to understand your policy.
How It Works
The accumulated cash value secures your loan. Once your policy grows enough, you can borrow a percentage of it, often up to 90%. This cash value guarantees the loan, so there’s no extensive approval process.
There’s usually no credit check, unlike personal loans. It’s less rigorous because your policy backs it. The repayment schedule is flexible and interest rates are often lower.
Types of Life Insurance That Allow Borrowing
Only cash value policies offer loans. Examples include whole life insurance, universal life insurance (UL), variable universal life insurance (VUL), and indexed universal life insurance (IUL).
Types of life insurance, such as term life insurance, don’t allow borrowing. These and similar options without cash value components cannot be used to get a life insurance loan or pay loan expenses. This may involve getting a new policy or even debt consolidation for some. You should always check with a financial advisor or financial professional before you make financial decisions about this.
Pros and Cons of Borrowing Against Life Insurance
Borrowing from your life insurance offers advantages, including speed. However, consider its impact on your death benefit. You will need to find an insurance company offering this and possibly switch over your policy or create a brand new life insurance policy with this in mind.
Pros
- Quick access to cash.
- Flexible repayment. No fixed payment schedule or penalties. The loan rate accrues as the interest accrues. Stay within cash value limits to prevent lapses. These rates can change and will not always be the rates when you get the insurance policy loan.
- Competitive interest rates on insurance loans (5-8%), often lower than credit cards, personal loans, student loans, balance transfers or auto loans.
Cons
- Reduced death benefit. The loan balance and unpaid interest is subtracted from the beneficiaries’ receive. Your outstanding loan amount may mean less your beneficiaries receive, and their access to your financial safety net can change as your loan balance increases.
- Risk of policy lapse. Unpaid interest exceeding your policy’s cash value can cause policy cancellation.
- Potential IRS guidelines income tax implications upon lapse or surrender. These policies could put your money at risk as this will not build credit nor repair credit, in fact, you can possibly ruin your chances at credit monitoring if the insurance company decides to charge a large amount. You will want to understand all of the complexities within the policy that affect beneficiaries received from your permanent life insurance policy or any term life policy for that matter.
Alternatives to Borrowing From Life Insurance
Sometimes alternatives are better. It’s wise to weigh different solutions. The below table should get you thinking about possible solutions. These can be better if you need small business funding as this will give a clear repayment schedule. While it is possible to pay off the policy loan whenever you want, not having a fixed schedule makes budgeting difficult, where small businesses will generally prefer more structured planning.
| Alternative | Pros | Cons |
|---|---|---|
| Personal Loans | Fixed repayment schedule, diverse options | Credit score dependent, possibly higher rates |
| Home Equity Loans/HELOCs | Lower rates (home as collateral), sizable loan amounts | Risk of foreclosure, stricter approval |
| 401(k) Loans | Easy access (employer-sponsored), potential tax advantages | Penalties for non-repayment if you leave your job |
| Credit Cards | Easy to Use, Rewards Credit Card options | Higher Rates than most loan types, Balance Transfers can save you money short-term |
| Savings Accounts/Money Market Accounts | Access to cash without a loan, CD Rates offer higher yield on savings | Lower Returns than other investments |
Borrowing Strategically: When It Makes Sense
Insurance loans help bridge financial gaps for major expenses like medical bills, home repairs, or investment opportunities. This is especially true if you can’t borrow through typical routes like taking out lines of credit with a bank. The rates could end up being better.
However, weigh all financial options before borrowing. Consider long-term benefits and potential financial strain. Understand how to borrow from life insurance.
Conclusion
Knowing how to borrow from life insurance offers additional financial options. While not ideal, it provides potential access to accumulated wealth. However, proceed with caution and consider the tradeoffs, especially the impact on your death benefit. Carefully assess your needs to determine if this or another financial route is your best option. Consult with your financial professional and they will assist in your research and give an overview on topics such as income tax implications or current mortgage rates and CD rates.
FAQs about how to borrow from life insurance
Can you borrow money out of a life insurance policy?
Yes, but only with permanent life insurance policies (whole or universal life) that have a cash value component. Term life policies don’t have this feature.
What is the cash value of a $10,000 life insurance policy?
Cash value isn’t tied to the death benefit. It grows separately based on premiums and investment performance within the policy. For a small business loan or larger financial planning expenses, other loan types or even CDs money from your CDs account could be a good option.
How long does it take to borrow money from life insurance?
It depends on the insurer and the minimum read you spent doing research, but typically takes a few weeks. You need sufficient cash value to borrow, usually built up by premium payments over years. Before borrowing, it’s best to discuss your financial options and life insurance with a financial advisor.
How to withdraw money from a life insurance policy?
You borrow against, not withdraw from, your policy’s cash value. Send a request to your life insurance company. After approval, funds are directly deposited into your checking account.
How is interest calculated on life insurance policy loans?
Interest on life insurance policy loans typically ranges from 5% to 8% and can be either fixed or variable. Variable rates fluctuate annually based on market benchmarks, while fixed rates remain constant throughout the loan. Many policies use either direct recognition or non-direct recognition methods, which affects how your cash value earns dividends on borrowed funds. With direct recognition policies, borrowed cash value may earn a different dividend rate than unborrowed funds, while non-direct recognition policies credit the same rate regardless of loans. The true cost of borrowing depends on the spread between what you’re charged and what your policy continues to earn.
What happens to my loan when I die?
When you pass away with an outstanding life insurance loan, the insurance company deducts the loan balance plus any accrued interest from your death benefit before paying your beneficiaries. For example, if you have a $250,000 death benefit but owe $50,000 on your loan, your beneficiaries will receive $200,000. The loan itself isn’t taxable as long as the policy remains in force until death. This is why it’s crucial to monitor your loan balance throughout your life, as a large outstanding loan can significantly reduce the financial protection you intended to provide for your loved ones.
What are best practices for repaying life insurance loans?
Best practices for managing life insurance loans include making at least the annual interest payments to prevent compound growth of your debt, even if you can’t repay the principal immediately. Monitor your loan balance regularly and compare it against your cash value to ensure you’re not approaching dangerous territory where your policy could lapse. Request an in-force illustration annually from your insurer to see projected policy performance with the loan. Consider setting up automatic payments for interest to avoid missing payments. If you used the loan strategically for investments or asset purchases, develop a disciplined repayment plan using returns from those investments to pay yourself back with interest, maximizing your policy’s long-term growth potential.
Can policy loans affect my cash value growth?
Yes, policy loans can affect your cash value growth depending on whether your policy uses direct recognition or non-direct recognition. With non-direct recognition policies, your entire cash value continues to earn the same dividend rate regardless of loans, meaning the loaned portion grows just like unborrowed funds. With direct recognition policies, the borrowed portion of your cash value may earn a different dividend rate, typically lower than the unborrowed portion. However, many direct recognition policies structure the dividend spread carefully so the net cost remains competitive. Your cash value technically stays in the policy when you take a loan since you’re borrowing from the insurance company using your policy as collateral, which allows uninterrupted compound growth.
