If you want to borrow from your life insurance, you must own a permanent life insurance policy. Term life insurance policies do not have a cash value component, so they are not eligible for loans. However, if you own permanent life insurance, like whole or universal, and you have built up a reserve of cash within it, you can usually borrow from it.
Like any type of loan, there are pros and cons to life insurance policy loans. It is essential to look at all aspects of the transaction before deciding whether to borrow against your whole life insurance policy.
Key Takeways
- You cannot borrow from term life insurance policies.
- You can only borrow from permanent life insurance policies when you have built up enough cash value.
- Unlike other loans, borrowing from an insurance policy doesn't require credit checks or payment plans.
- You don't have to repay an insurance policy loan, but if you don't pay it back, you could owe taxes or face a lowered death benefit.
- If you need quick access to cash, a life insurance policy loan is an easy way to obtain money.
Pros
It doesn't take long to access your loan funds.
You can use the loan funds for whatever you choose.
Loans do not have to be paid back.
Money from an insurance policy loan is not taxed as income.
Cons
The death benefit will decrease if the loan isn't repaid.
You will owe interest on the loan.
Failing to repay your loan may result in losing insurance coverage
Pros of a Life Insurance PolicyLoan
It doesn't take long to access your loan funds: Gettinga life insurance policy loan is quick and easy. Since you are borrowing against your own assets, there is no approval process, credit check, or income verification. Policy loans generally have a much lower interest rate than bank loans and do not charge high fees or closing costs. In most cases, they are also tax-free. Most companies allow you to borrow up to 90% of your cash value. After you request the loan, you will usually receive a check in about a week.
You can use the loan funds for whatever you choose: Because your policy'scash valueacts ascollateralfor the loan, you can use the money for anything from household bills to a vacation. The insurance company does not require you to explain how you intend to use the funds.
Loans do not have to be paid back: Unlike with a bank loan or credit card, there is no required monthly payment for a policy loan and no payback date. You can pay it off in two months or let it sit without making any payments for years. However, an unpaid loan accrues interest that is added to your owed balance.
Money from an insurance policy loan is not taxed as income: Policy loans are not considered taxable income. You can borrow all your cash value, even earnings above what you paid in premiums, without owing income tax. In comparison, if you took money out with a withdrawal, you would owe income tax for taking out your earnings.
Cons of a Life Insurance Policy Loan
The death benefit will decrease if the loan isn't repaid: Ifyou were to die before paying back your policy loan, the loan balance plus the interest accrued is subtracted from the death benefit that would be given to your beneficiaries. This could be a problem if your beneficiaries need the entire amount of the intended benefit.
You will owe interest on the loan: Between the time you take out the loan and the time you repay it, the insurance company will charge you interest on the outstanding balance. Paying down the loan reduces the interest accumulated, but the interest will continue to be charged until the loan plus interest is entirely paid off.
Failing to repay your loan may result in losing insurance coverage: If the loan balance increases above the amount of the cash value, your policy could lapse and risk termination by the insurance company. You would lose your insurance protection. In addition, your loan would then be reclassified as a withdrawal. You would owe income tax on any amount you received above what you paid in life insurance premiums.
What Does It Mean to Take out a Policy Loan?
A policy loan usually refers to a life insurance policy loan, which occurs when you borrow from the cash value component in your permanent life insurance policy.
What Are the Consequences of a Policy Loan?
First, you owe interest on the outstanding policy loan. Second, if you die with an outstanding loan, the insurer will deduct this from the death benefit so your heirs receive less money. Third, if the loan plus interest grows to exceed the value of your cash value, your policy could lapse and you would lose your life insurance protection. Weigh these consequences before borrowing.
Are Policy Loans Repayable?
Yes, policy loans are repayable. If you pay back the entire loan with any owe interest, your heirs would then once again receive the full policy death benefit after you pass away. After you repay a policy loan, you could also borrow the cash value again in the future.
How Is a Policy Loan Funded?
You fund a life insurance policy loan with your cash value. Permanent policies, like whole life and universal life, build cash value from your premium payments which you can borrow against while alive. After several years of premium payments, you should have enough cash value to borrow.
The Bottom Line
A big benefit of permanent life insurance is its cash value component, which you can legally borrow against after several years of accumulation. A loan lets you take out your cash value tax-free and use it however you want. But before borrowing, make sure you understand how an outstanding loan could impact your policy and the future payout for your heirs. Weighing the pros and cons of borrowing from a life insurance policy allows you to make an informed decision about whether a policy loan is right for you.
