Can I borrow money from a life insurance policy?
Life insurance protects your family from financial hardship if you pass away, but there are some policies that allow you to borrow money from your life insurance policy while you’re alive. These policies can help pay for big financial commitments like starting a business or funding a child’s college education.
Most permanent life insurance (such as whole life insurance) provides not only a death benefit when you die, but has a cash value component. When you pay your premiums, part of the money goes toward the death benefit and part goes into a cash value account. That cash value is what you can borrow from if you’ve had the policy long enough to build up a fund. Term life insurance policies do not offer this option because they do not have a cash value component, only a death benefit.
Which types of life insurance can you borrow from?
There are two types of life insurance, permanent and term. Permanent life insurance means the plan will provide coverage for the rest of your life as long as the premiums are paid. Term life insurance means you’ve chosen the length of time (or term) you want to be insured, and as long as premiums are paid, you will be insured until the end of that term.
Permanent life insurance policies (whole life insurance and universal life insurance) have a cash value account, which builds up over time, as well as the death benefit. Term life insurance policies provide a death benefit, but have no cash value component. You can borrow money from a permanent life insurance policy once the cash value has built up to the borrowing threshold, which will be determined by the carrier and the specific policy you choose. It’s important to understand your insurance policy is used as collateral for the loan, and if it is not paid back it could decrease the death benefit.
When does it make sense to borrow from your life insurance policy?
There are a few times it makes more sense to borrow from your life insurance policy than it does to borrow from a bank. For instance, it would be easier to borrow from your life insurance policy during times of financial hardship when a bank has turned down a loan. Other reasons include:
Paying off a high-interest loan or credit card
Paying tuition for school
Starting a business
Loans from your life insurance policy will have lower interest rates than a typical bank loan, so it might benefit you to consider a life insurance loan if you’re borrowing a significant amount or for a long time. These loans are fairly easy to qualify for and give you quick access to funds, you should just need to fill out a loan application with your insurance provider.
Advantages and Disadvantages of Borrowing From Your Policy
Borrowing money from your life insurance policy has both advantages and disadvantages. You’ll want to fully understand both sides before you make a decision about what is best for you.
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 fairly low interest rate, which makes it a good financing option. The rate will depend on whether it is a fixed or variable rate.
You set the repayment schedule. There is no set repayment schedule because you decide when and how much you want to pay back. This allows you to build the repayment schedule so it fits your budget. It’s important to remember not to let your premiums lapse while you’re repaying your loan.
No restrictions on how to use funds. 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.
Disadvantages of borrowing from your life insurance include:
It takes time to hit the cash value threshold. You must have a certain amount of cash value built up before you can borrow a loan, and that amount can take many years to accrue. If your policy hasn’t hit the cash value threshold, you can’t access funds to get a loan.
Withdrawal limits. Withdrawal limits are set by each insurer, but it’s typically a percentage of the cash value account. If you need to borrow more than that amount, you might have to look into other types of loans.
Reduced death benefit. If you don’t pay back your loan or can’t pay it back before you pass away, the amount will be taken out of your death benefit. Your beneficiaries stand to receive less than you originally planned if the loan is not paid back in full.
You run the risk of policy lapse. There is no set payment schedule, but interest will continue to accrue on the loan until it is repaid in full. If the amount you owe on the life insurance policy loan is ever more than the cash value of the account, your entire policy will likely lapse.
There are tax implications. If you don’t repay your loan or if your policy lapses, you may owe taxes on the amount you borrowed.
There are other options that don’t include borrowing from your policy. You might be able to make a withdrawal of the policy’s cash value, which would be tax-free if it does not exceed the amount you have paid in premiums. Another route is to surrender your policy for cash, which could be an option for you if you no longer have dependents or large debts that will need to be paid after you pass away. Note you’ll likely pay a surrender fee if you choose this option.
How to Get the Process of Borrowing Started
If you have a life insurance policy that has a cash value component and it has hit its threshold so you can borrow from it, your next step is contacting your insurance company. There isn’t a lot of paperwork or a formal approval process like with a typical loan but there will still be an application form to fill out. Interest will begin to accrue immediately and it will accrue at a rate your insurer determines. The withdrawal may be handled as a cash surrender or can be repaid like a loan. If it’s handled like a cash surrender, your life insurance company will pay out the cash value and end your plan. If it’s handled like a loan, repayment could begin immediately, likely on a monthly basis like your insurance premiums.
Let SelectQuote Help Find the Right Life Insurance For You
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