How Does Borrowing Against Life Insurance Work?

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Borrowing is a way of life in America. You can borrow until your next paycheck with a payday loan, against next month with a credit card, against owning your own home with a mortgage loan, or against your own retirement with a 401(k) loan. 

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But can you borrow against your life insurance policy? Many Americans ask that when they’re in a tight spot financially. According to an insurance report made available by life insurance research company LIMRA, just under 60% of U.S. adult household decision-makers are covered by some form of life insurance policy.

Some of these policies, like whole life (a type of permanent life insurance), accumulate money over time in a savings component of the policy called the “cash value.” Term life insurance, which is very popular because of its low price, doesn’t accumulate cash value.

So can you borrow the cash value of your life insurance policy? Let’s find out.

Can You Borrow Against Your Life Insurance Policy?

Though most people initially buy whole life insurance to provide a lump sum of money for loved ones when they die, when the mortgage is paid off and the kids have moved out on their own, the need for the death benefit of the policy decreases. As that is happening, the cash value portion of the life insurance policy is steadily increasing over the years.

This cash value is a tangible asset that can be listed on your personal balance sheet when you’re figuring your net worth, just as money in an IRA or CD counts as an asset. Since it’s an asset you own, you are able to borrow it from your life insurance policy.

Now that you know you can borrow against your life insurance policy to access the cash value, another question to ask is if it’s a good idea to do that. To help you answer that, let’s look at the pros and cons of taking out a policy loan.

Pros of Borrowing Against a Life Insurance Policy

Whether you need money to pay your child’s college tuition, pay a lingering medical bill, or take a vacation, borrowing cash value from your life insurance policy has some advantages over personal loans or credit cards.

  • There is no credit check. If you have enough cash value in your policy, you can borrow from it with no questions asked.
  • There is no application process. Unlike bank loans, there’s no formal application process. Simply filling out a form will start the process of borrowing from the cash value in your policy.
  • Loans don’t appear on your credit report. This is unlike bank loans and credit card debt.
  • Policy loans have low interest rates. Interest rates on a policy loan vary from insurer to insurer, but they typically will range from 3% to 6%. Data from the Federal Reserve shows this is less than the average rate on a two-year personal loan (10.21%) or a credit card (16.88%).
  • Loans have no timetable for repayment. You can repay it on your own schedule, not the insurance company’s.
  • The loan doesn’t have to be repaid. The outstanding loan balance will be deducted from the policy’s death benefit if you choose not to repay it.

Cons of Borrowing Against a Life Insurance Policy

The benefits of borrowing against life insurance sound too good to be true, don’t they? Of course, any time you can get quick cash, you’re going to find some drawbacks. Policy loans are no exception.

  • Cash may not be available. A policy’s cash value takes many years to build up. In the early years of the policy, there may be little, if any, cash value to borrow against.
  • The death benefit can be reduced. If you don’t repay the loan while you’re living, the death benefit will be reduced by the outstanding loan balance, which may be to the detriment of your beneficiaries.
  • There’s a risk of losing coverage. If your loan plus interest is more than your policy’s cash value, your policy could lapse.
  • Interest accumulates. Although the rates may be favorable, you’re still paying interest, which is subtracted from the remaining cash value.
  • There are possible tax consequences. You may have to pay taxes on some of the cash value you borrowed if your policy lapses before you’ve paid the entire loan balance in full.

When Are You Allowed to (And Not Allowed to) Borrow Against a Life Insurance Policy?

When you can borrow against your cash value is going to depend on the policy terms, which can vary for different life insurance companies. The policy will contain a cash value chart.

Whole life insurance accumulates cash value at a minimum guaranteed interest rate, and some policies also have a guaranteed cash value. Your cash value is going to depend on the policy and the insurer; some policies accumulate cash value faster than others.

Steps For Borrowing Against a Life Insurance Policy

Whether it be for a medical emergency, much-needed home repairs, or a new transmission you can’t pay afford at the moment, at some point you may need a quick infusion of cash. Borrowing from the cash value of your whole life insurance policy can be a great way to access money quickly. It’s easy to take out the loan if you know how. Here are three steps:

  1. Contact the insurer to obtain the necessary forms. Most life insurance companies will send you the paperwork by snail mail, and they will  also have them downloadable on their website. One company even lets policyholders call policyholder services if the loan amount is $25,000 or less.
  2. Properly identify the owner of the life insurance policy. Whether the owner of the policy is an individual, a trust, or a business affects how the loan application is completed and what information is needed. If a trust owns the policy, you need to know the date the trust was signed and have a trustee with the proper legal authority handle the transaction. For a business, the owner’s contact information, as well as a Social Security number or tax ID will have to be provided.
  3. Determine the payout method. One of the questions you’ll be asked on the paperwork is how you want the proceeds paid to you. This is going to depend on your reason for taking out the loan. If it’s for personal reasons, you can have them send you a check, which usually takes five to ten business days, or do a direct deposit to your bank account electronically, which is much quicker.

You can also use your loan to pay future premiums. People sometimes do this if they don’t have funds available to pay the premiums out-of-pocket and they don’t want their policy to lapse.

Be sure to keep track of the loan. Since there are no required monthly payments and you don’t have to repay the loan, it can be easy to forget about it and have the interest owed grow substantially without you knowing about it. Some guidelines to follow to keep track of your loan are:

  • Monitor the loan balance regularly and compare it to the cash value. This is important because your policy can lapse if your outstanding loan balance exceeds the policy’s cash value.
  • Create a disciplined repayment plan and make the scheduled payments. Remember, any outstanding loan amount when you die is deducted from your cash value, which can harm your beneficiary financially.
  • Pay the interest on the loan every year. This will prevent the loan amount from increasing.

Alternatives to Borrowing Against a Life Insurance Policy

You have a number of alternatives to borrowing cash value from your life insurance policy, including the following. 

Alternatives using your life insurance

Some alternative options you have using your insurance policy include:

  • Policy surrender value. If you don’t intend to own your policy any longer, you can let the insurance company know that you want to cash out and receive its surrender value.
  • Life settlement. A life settlement is the sale of your life insurance policy to a third party for a lump sum of cash. The amount of cash you receive will be less than the face amount of your policy—typically anywhere between 10% and 35%. The policy stays in force because the new policy owner will pay the premiums. You’ll still be the insured individual, but when you die, your beneficiaries won’t receive the death benefit; the new policy owner’s beneficiaries will.
  • Viatical settlement. This is meant for someone who is terminally ill and operates much the same as a life settlement. The policy is sold to a third party for a lump sum of money, who will then make future premium payments. Their beneficiaries will receive the death benefit when you die.
  • Accelerated death benefit (ADB). Some policies contain a provision that allows you to receive a portion of your death benefit before you die. The requirements to receive the ADB usually include you having to be terminally ill with a life expectancy of less than two years or being permanently transferred to a nursing home because you can’t perform two of the activities of daily living (eating, bathing, dressing, toileting, transferring).

Non-insurance alternatives

Non-insurance alternatives to provide you with quick cash are:

  • Personal loan. Though the interest rates for personal loans are lower than those for credit cards, they’re still much higher than a life insurance policy loan. Personal loans can be obtained from a bank, credit union, or online lender. Check your credit score before taking out the loan to be sure there aren’t inaccuracies that could hurt your ability to obtain the loan. A strong credit score will help you qualify for the best rates and terms.
  • 0% APR introductory credit card. This can be a better alternative than a lower-interest personal loan if you can pay off the balance before the promotional period ends and the interest rate increases to an exorbitant rate.
  • Credit card cash advance. Most credit card issuers allow you to borrow a set amount of money through a cash advance. The amount can be a few hundred to a few thousand dollars, depending on the type of card you have. The downside of this alternative is three-fold: you’ll pay an even higher interest rate than your card’s standard rate, you’ll pay additional fees, and you might lower your credit score by increasing your credit utilization ratio.
  • Home equity loan. This option allows you to borrow against a percentage of your home’s equity at a fixed interest rate. Though interest rates are lower than those for personal loans and credit cards, you’ll have to pay closing costs, which will be roughly 2% to 5% of the amount you borrow. It will also then take you longer to pay off your mortgage, and you risk foreclosure on your home if you become delinquent on your loan payments.

Should You Borrow From Cash Value Life Insurance?

The question of whether or not you can borrow against your life insurance policy has been answered (yes), but it also leads to another question: should you?

If you’d like to keep your policy and don’t want to exercise any of the alternatives we just looked at, a loan is a good alternative; it’s much better than running up your credit card balances or paying extremely high interest on a personal loan.

Bottom Line

Before deciding to borrow against your life insurance policy, consider what the effect will be on your long-term financial goals. You may be solving a short-term problem but negatively impacting your future financial life.

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