The comprehensive guide to borrowing against life insurance

So far, you have probably heard all about life insurance and life insurance policies you can buy, but have you heard about borrowing against life insurance?

That’s a possibility we encourage you to explore, as it’s proven to bring multiple benefits to policyholders. Let’s get to the bottom of it!

Can you borrow against life insurance?

To answer this question, let’s first discuss what a life insurance policy loan is.

If you are a proud owner of almost any permanent cash value life insurance policy, then you can take out a loan from your policy’s cash value. In other words – when you borrow the money from your life insurance policy – you are borrowing your own money. This is reflected in the money being taken away from your premium payments and stored in your savings account.

A life insurance policy loan is an outstanding loan from a couple of aspects. If you pass away without repaying the loan, it will be subtracted from your death benefit (including the interest rate).

That is another thing that you should know – even though you are not required to repay the loan, you should expect to be charged the interest when placing the loan by the life insurance company.

To answer your initial question – if you are a policyholder of a life insurance policy, yes – you can borrow against life insurance. Now, let’s learn how.

How to borrow against life insurance

Because you are borrowing against life insurance – in other words – your own money, there is no complicated procedure in place.

One of the advantages of a life insurance loan is that you can borrow against life insurance as soon as you have sufficient funds in your cash value account. You also don’t have to worry about the amount of money you are taking out or explaining what do you need the money for, as there are no limitations or special requirements to be fulfilled.

Simply, if you want to take out a loan, you should contact your insurance company to let them know. They will explain to you the simple procedure, and soon you will have your funds available to be used as you find the most suitable.

Bear in mind that this would be the best moment to ask your insurer about the interest rate. Even though you are borrowing your own money, interest is paid to the insurance company – either with a permanent or variable rate.

If it is a fixed interest rate, you will know exactly how much you are expected to pay every year. On the other hand, the variable interest rates can vary from year to year, and you can expect them to be disclosed on your policy’s annual statement.

You should also know that even though you have taken out the money from your savings account, it can still grow.

These gains will be delivered to you in the form of dividends at the end of the fiscal year, but most probably with a lower rate; If you decide to return your loan, make sure that you check with your insurance agent whether the repayment date should be set.

Don’t forget that this is a unique loan that does not require you to repay it while you are alive, but if you choose this option – your beneficiaries will repay it in a way since they will receive the payout minus the loan balance.

Should I borrow against life insurance?

We are reading your mind, aren’t we? If this is what you were thinking about, here is the list of advantages and disadvantages of borrowing against life insurance to answer your question.

Advantages of borrowing against life insurance

  1. No questions asked
    It is as simple as that – you can take out the personal loan without answering the questions about your motivation, needs, and intentions. This is a big difference compared to the usual procedure of getting a loan.
  2. No application process
    Going through the application process and worrying about the credit score are things you’re not going to miss if you choose to borrow against life insurance. Contacting your insurance company and filling out the form is the only process you will have to go through.
  3. Tax-free loans
    A life insurance policy loan will not lend in your credit report, which means you won’t be charged the income tax for it as you would for any other type of loan.
  4. Lower interest rates
    Paying the interest rate is a standard part of taking the loan, but it doesn’t have to be as high as we are used to with bank loans – on the contrary, life insurance policy loans have lower interest rates.
  5. Flexible repayment
    You already know the loan repayment is optional – you can also choose not to pay the debt, but it means that your beneficiaries will. That’s why we prefer to use the term flexible repayment – you can make your repayment schedule.
  6. (Almost) No limit
    If you have managed to build up cash value over the years, you can borrow up to 95% of it; the more you have accumulated, the bigger the loan.

Disadvantages of borrowing against life insurance

  1. Insufficient funds
    As we mentioned before, the first step in the process of borrowing your own money is actually to have it. Bear in mind that building up cash value might take years (or even decades!), so the funds you can borrow might not be available soon.
  2. The lower death benefit payout
    We purchase life insurance policies mostly because we care about our loved ones. Then it might be contradictory to lower the death benefit payout they’re expecting by not returning our loan. This the risk that comes with borrowing against life insurance.
  3. A significant risk of losing the insurance coverage
    When we say ‘a significant risk of losing the insurance coverage,’ we want to emphasize the immense impact that would have on you. When you take out the loan, you are expected to pay the loan interest, which is done automatically by taking the interest rate out of your death benefit. If you are not careful enough, you might find yourself in an unpleasant situation of losing your coverage.
  4. Possible tax implications
    If you find yourself losing your coverage (your policy lapses) and not repaying the loan, the deferred taxes would not be applied anymore. That means that besides losing the coverage, you would also have to pay the tax bill on the loan you previously took out.

Life Insurance you can borrow against

Unfortunately, you can not borrow against any life insurance. To be able to take out the loan, you must own a whole life insurance policy or permanent life insurance policy. That is a type of life insurance that consists of a cash value component that allows you to build cash value over time.

Remember – to take out the loan – you need to have your money previously saved. Those savings are being stored in the cash value account.

Can you borrow money from term life insurance policies?

Even though term life insurance has many benefits – for instance – premiums are cheaper, it also comes with some setbacks. One of them is that you do not accumulate cash value over time. Therefore you can not borrow the money from a term life insurance policy.

Another thing to be cautious of when it comes to the term life insurance is that even the policy’s death benefit is not guaranteed with this type of insurance, in case the policy owner outlives the fixed term from the contract.

Examples of borrowing against life insurance

Brad was a healthy man in his forties, looking forward to enjoying the hobbies in his life. He always dreamed about owning a golf club where he would spend his weekends with his closest friends. Brad finally reached a point where he almost had all of the funds to afford it. For the rest of it – he thought of borrowing against life insurance. What seemed like a good idea in the first place was soon put away. Brad’s financial advisor explained that even though this might have seemed like the easiest way to reach the goal, he could be putting his family at significant risk by obligating himself to interest payments in the upcoming years.

A couple of years later, Brad again consulted his financial advisor – he was thinking of expanding his business as the demand for it was pretty high, but he needed a loan. Brad got a green light from the financial advisor this time because they calculated that the loan amount could be repaid in the next two years, leaving Brad’s family out of the risk.

Borrowing against life insurance is always an option – just make sure you take all of the factors into consideration before making the final call.

The bottom line

Borrowing against life insurance is an outstanding opportunity not many of us have. That’s what makes it so important to deeply understand how borrowing works – the benefits and the possible consequences if we are not careful enough.

If you want to create a safety net for your family and an easily accessible fund, then a life insurance policy loan might be the perfect solution for you. If you follow through with all of the advice we mentioned above, we believe you will be pretty successful in your quest.