How to Borrow From Your Life Insurance Policy

Your permanent life insurance policy offers a benefit you may not have realized: the ability to access cash liquidity while you’re still alive. Understanding how to borrow against your life insurance policy without jeopardizing it is important. 

While there are significant benefits to life insurance policy loans—such as tax-free access to cash and no credit checks—there are also risks to consider, including interest accrual and the potential for a policy lapse. Whether you're looking to capitalize on a business opportunity or fund a grandchild’s education, borrowing from your life insurance policy can be a powerful financial tool.

How Policy Borrowing Works

To determine whether you can borrow from your life insurance, you need to have the right type of coverage. There are two primary categories of life insurance: term and permanent. Term life insurance is designed to provide protection for a specific period—such as 10, 20, or 30 years—and offers only a death benefit. Because it lacks a savings component, you can’t borrow against a term policy.

Permanent life insurance, however, is intended to last your entire life. Most of these policies—including whole life and universal life—feature a cash value component. As you pay your premiums, a portion accumulates in this tax-deferred account. Once you’ve built up sufficient equity, you can borrow against life insurance to support your broader wealth strategy. Note that term life insurance doesn’t offer this feature, as it’s designed strictly for death benefit protection.

Your Cash Value as Collateral

When you take out a policy loan, it’s a common misunderstanding that you're withdrawing your own money. In reality, the insurance company provides the funds from its own capital, using your policy’s cash value as a "security deposit" or collateral.

Because your money stays in the account, it can continue to earn interest or dividends even while you're using the loan proceeds elsewhere. This means you don't have to provide additional collateral or go through a secondary approval process; the equity you’ve built in your policy is all the security the carrier needs.

What MEC Status Means and Why it Matters

When managing a high-value policy, you must be mindful of the "7-pay test." This is a calculation used by the IRS to determine if a life insurance policy is overfunded. Essentially, the test limits the amount of money you can pay into your policy during its first seven years. If your total premiums exceed the amount needed to have the policy paid up in seven years—or if a loan is structured improperly—the IRS reclassifies it as a modified endowment contract (MEC).

Once a policy becomes an MEC, it permanently loses many of its most attractive tax benefits. Loans and withdrawals are no longer tax-free; instead, they are treated as taxable income on a "last-in, first-out" basis. This means you would be taxed on any gains first. Our experienced agents can help you find the right coverage while maintaining non-MEC status under IRS Section 7702, ensuring borrowing remains tax-advantaged.

The Concept of Arbitrage

For those with an indexed universal life (IUL) policy, borrowing can sometimes lead to a strategy known as arbitrage. This happens when the interest rate you're earning on your cash value is higher than the interest rate the insurance company is charging you for the loan. While this can be a sophisticated way to grow wealth, it does come with inherent risks—if the market index underperforms, the loan interest could outpace your growth. It’s a strategy best navigated with a seasoned professional to ensure your financial assets remain protected.

Comparing Permanent Policy Options

Different permanent policies accumulate value and handle loans in unique ways. Our experienced agents can help you determine which structure aligns best with your long-term estate goals.

The Benefits of Life Insurance Policy Loans

While many view their coverage primarily as a safety net, it can be used as a strategic source of liquidity. There are times when borrowing from your life insurance policy offers distinct advantages over traditional banking. Advantages of borrowing from your life insurance policy include:

• No Credit Check: You’re borrowing your own money, so a hard credit check isn’t required. If a credit check is done, it’ll be a soft credit check that won’t impact your credit rating. This is a great way to borrow money if you have a poor credit score.

• No Additional Collateral: The collateral used for the loan will be the life insurance policy itself. You don’t risk any of your other assets by taking out this loan like you might a loan through a bank or credit union.

• Low Interest Rates: A life insurance policy loan typically offers a low interest rate, making it a good financing option. The rate will depend on whether it is a fixed or variable rate.

• Flexible Repayment Schedule: There is no set repayment schedule; you decide when and how much to pay back. This allows you to build a repayment schedule that fits your budget. It’s important to remember not to let your premiums lapse.

• No Restrictions on Use: You can use the money you borrow from your life insurance policy to pay for anything you want. There are no restrictions on how it must be spent.

The Risks of Borrowing from Your Life Insurance

While policy loans offer significant flexibility, they require a balanced approach to ensure your long-term goals remain on track. Borrowing against your policy isn't without its complexities—understanding the potential pitfalls is the best way to avoid them.

• The Waiting Period for Equity: It takes time to build the necessary cash value before you can access a loan. Depending on your policy type and premium structure, it may take several years of premium payments before you hit the required threshold for borrowing.

• The Impact on Your Beneficiaries: One of the most critical things to remember is that an outstanding loan, including accrued interest, is deducted from the final payout. If the loan isn't repaid before you pass away, your loved ones may receive less than you originally intended for your legacy.

• The Danger of Policy Lapse: Because there's no mandatory repayment schedule, it's easy to let interest accumulate. If the total loan balance ever exceeds the cash value of your account, the policy could lapse—leaving you without coverage and potentially triggering a significant tax bill.

• Capital Access Limits: Carriers typically limit loans to a specific percentage of your cash value rather than the full amount. If you need more capital than your policy allows, we can help you explore other financial tools that might better suit your goals.

Alternatives to Policy Loans

If a loan doesn't feel like the right fit for your situation, there are other ways to access the value you’ve built:

• Cash Value Withdrawal: This is typically tax-free up to the "basis" (the amount you’ve paid in premiums), but it permanently reduces your death benefit.

• Policy Surrender: You can cancel the policy for its net cash value. This is usually a last resort for those who no longer have dependents, as it ends your coverage and may involve surrender fees.

Whatever options you may want to explore, we can help you weigh different policies against your estate planning goals to ensure your family's peace of mind remains the top priority.

When should you borrow?

Deciding when to access a policy's equity is a significant financial choice. Most people consider this approach when they need efficient liquidity without the restrictions of traditional lending. Because the loan is secured by the policy itself, it offers a level of financial flexibility that is independent of traditional banking cycles or credit markets.

Strategic Uses for Cash Value

For the people we work with, the flexibility of a policy loan often serves as a tactical advantage in a broader financial plan. Some of the leading reasons individuals consider this avenue of funding include:

• Investing in Business Ventures: You can secure capital quickly for a new opportunity or a business expansion without the delays of commercial lending.

• Funding Family Milestones: Whether you’re providing for a grandchild’s education or supporting a child's major life event, you can access funds without liquidating other market-sensitive investments.

• Streamlining Cash Flow: Policy loans typically offer lower interest rates than unsecured bank loans or lines of credit, making them an efficient tool for managing significant expenses.

• Tax-Advantaged Liquidity: A key benefit for many is that the IRS generally doesn't tax policy loans. This provides a way to access cash without triggering the capital gains or income tax liabilities that often accompany the sale of other financial assets.

How to Start the Process

If a policy has reached its borrowing threshold, the process is generally straightforward. Because the loan relationship is between the policyholder and the insurance carrier, there's no formal approval or hard credit check; the process typically involves submitting a brief application directly to the insurer. Interest accrues immediately at a rate determined by the carrier.

While the payout can be handled as a cash surrender—which pays out the value but ends the coverage—most people prefer the loan route to maintain their peace of mind and keep the death benefit active. Reviewing the specific terms of a policy’s contract is the best way to ensure the chosen path aligns with long-term financial goals.

Comparing Loans to Return of Premium (ROP)

It’s important to clarify a common point of confusion when reviewing coverage: it’s not possible to borrow from a return of premium (ROP) policy. While ROP is a unique type of term insurance that returns premiums if the policyholder outlives the term, it doesn’t build a cash value account.

Borrowing is a feature exclusive to permanent plans—such as whole life or universal life—where a portion of the premium is directed into a tax-deferred accumulation account. If the goal is to have a policy that doubles as a source of liquidity, a permanent plan is the industry standard.

Find the Right Life Insurance For You

SelectQuote helps simplify the overwhelming process of shopping for and understanding life insurance. An experienced licensed SelectQuote agent who specializes in life insurance can help you decide if a permanent life insurance policy that has a cash value component is right for you. We can walk you through the process and answer any questions you have along the way. 

We work with some of the most trusted names in insurance, and our proprietary technology streamlines the search for life insurance that fits your situation in just minutes, saving you time and money. Join more than 60 million people who have trusted SelectQuote for their insurance needs.

This content is for informational and educational purposes only and does not constitute professional financial, investment, or legal advice. While we strive for accuracy (see our Editorial Standards), financial markets and laws change frequently. We recommend consulting with a qualified financial professional or attorney before making any major decisions.