Borrowing Against Life Insurance: How Policy Loans Work

Rebecca Parson
Rebecca Parson

Rebecca Parson

Author

Rebecca Parson is a financial and tech writer with 10 years of experience writing about topics such as life insurance, commodities investing, and the SaaS industry. She has a master’s degree from Johns Hopkins University and a bachelor’s degree from the University of Mary Washington. Her writing has appeared at money.com, sacbee.com, cart.com, herodevs.com, blanchardgold.com, and more.

Brian OConnel
Brian OConnel

Brian O'Connel

Contributor

Brian O’Connell has been a contributing writer for U.S News & World Report since 2016. A former Wall Street bond trader and the author of two best-selling books; “The 401k Millionaire” and “CNBC’s Creating Wealth”, he has 20 years experience covering business news and trends, particularly in the business and financial sectors. He believes education is the best gift a financial consumer can receive – and brings that philosophy to every story he writes. His byline has appeared in dozens of top-tier national business publications, including CBS News, Bloomberg, Time, MSN Money, The Wall Street Journal, CNBC, TheStreet.com, Yahoo Finance, CBS Marketwatch, and many more.

By Rebecca Parson, Brian O'Connel
Author, Contributor, Life Insurance

You can take out a life insurance policy loan if you have a cash value policy, like universal life or whole life insurance. These are both permanent plans, unlike term life insurance.

Borrowing against life insurance offers benefits like low interest rates, flexible repayment terms, and no credit checks. But it also reduces the death benefit, risks policy lapse, and can accumulate significant interest.

To borrow from your life insurance policy, you must first build up cash value by paying into your policy. Typically, it takes at least two years of payments before you can borrow a substantial amount against your permanent life insurance policy.

Key Takeaways

  • Borrowing from a life insurance policy is a convenient way to access cash when you need it.
  • The only life insurance you can borrow from is a permanent policy like whole, universal, or variable life insurance, not term life insurance.
  • Insurance loans accrue interest, and unpaid interest can lead to policy lapse.
  • If you don’t repay a policy loan, it reduces the death benefit payable to beneficiaries.

How Do Policy Loans Work?

Life insurance policy loans don’t impact your credit score, and you won’t need to get approval or do a credit check since you’re borrowing from your own funds. You can use the money for anything, from paying for a financial emergency to medical expenses or a vacation. 

And since the IRS doesn’t consider the loan income, it’s tax-free as long as you keep your policy active and its cash value doesn’t exceed legal limits (i.e., it’s not a modified endowment contract).

Paying Back the Life Insurance Loan

You’ll still have to repay the policy loan with interest, but there’s no mandatory minimum monthly payment. That said, if you don’t repay the interest, it adds to the loan balance and accrues, risking the loan amount exceeding the policy’s cash value and causing a lapse. If the policy lapses, you’ll owe taxes on the borrowed life insurance amount.

Insurance companies usually offer several options to keep the loan current so the policy doesn’t lapse. But if the loan is unpaid when the insured person dies, the loan balance plus any owed interest is deducted from the beneficiaries’ death benefit.

Can You Borrow Against Term Life Insurance?

No, you can’t borrow against term life insurance because it doesn’t have cash value. You may, however, be able to convert your term life policy to a permanent one, which would then let you build cash value.

What Is the Interest Rate on Life Insurance Loans?

The interest rate for an insurance policy loan is usually 5-8%, but it varies. It’s usually lower than the interest rate on a personal loan.

How Soon Can You Borrow Against a Life Insurance Policy?

You can borrow against a life insurance policy as soon as you’ve built up enough cash value, which usually takes a few years. When you first buy a policy, the cash value is zero. As you pay your premiums, part of each payment goes into the cash value, which grows tax-free.

The cash value growth in whole life and universal life policies varies. Some policies grow with a guaranteed interest rate, while others depend on variable stock market performance. The time it takes to build enough cash value to borrow against depends on your policy’s performance.

How Much Can I Borrow From My Life Insurance Policy?

You can borrow up to 90% of your life insurance policy’s cash value, although the specific percentage varies depending on the insurance company.

What Is an Example of a Policy Loan?

Let’s look at an example of how a life insurance policy loan would work. Mark has a whole life policy with a $300,000 death benefit and a $45,000 current cash value. He takes out a $25,000 loan against his cash value at 7% interest to help pay for medical expenses. 

But Mark unexpectedly dies five years later and hasn’t made any payments on the loan, which has increased to about $35,000 due to accrued interest of $10,000.

The insurance company subtracts $35,000 from the $300,000 death benefit, leaving Mark’s beneficiaries with $265,000 instead of $300,000.

How to Borrow Against Life Insurance

To borrow against life insurance, follow these steps:

  1. Verify Eligibility: Confirm your policy is a permanent life insurance policy, like universal, variable, or whole life. Term life insurance policies don’t have cash value, so you can’t borrow against them.
  2. Check Cash Value: Make sure your policy has enough cash value to borrow against. It typically takes a few years for a policy to accumulate sufficient cash value.
  3. Contact Your Insurer: Contact your insurance company to learn the specific requirements and process for taking a loan against your policy. Some insurers may allow online applications, while others require paper forms.
  4. Submit a Loan Request: Complete the necessary forms to request a loan. You may need to provide identification and policy details but won’t need a credit check or income verification.
  5. Read the Contract: Review the interest rate and repayment terms. Policy loans generally have lower interest rates compared to personal loans and credit cards. Be aware of how interest will accrue.
  6. Use the Funds: Once approved, use the loan funds for any purpose. The loan is tax-free as long as the policy remains active and is not classified as a modified endowment contract.
  7. Make Repayments: Make regular payments to avoid accruing excessive interest and reduce the risk of policy lapse.
  8. Monitor Policy Status: Make sure your loan balance doesn’t exceed your cash value as interest accrues.
  9. Plan for Beneficiaries: Remember that any outstanding loan balance plus interest will be deducted from the death benefit paid to your beneficiaries. Factor this into your estate planning.

Pros and Cons of Life Insurance Lending

A policy loan offers tax-free cash that doesn’t impact your credit score and allows flexible repayment. However, it reduces the death benefit and may cause a policy lapse if not repaid. Getting a loan on a policy of life insurance is a decision to weigh carefully.

What Are the Advantages of a Policy Loan?

The primary advantages of a policy loan are:

  • The IRS doesn’t classify policy loans as income, so they’re tax-free. 
  • You can use the money for any purpose.
  • You can repay the loan on your own schedule.
  • The loan won’t impact your credit score.
  • Your credit score won’t determine the interest rate.

What Are the Disadvantages of a Policy Loan?

It’s important to consider the downsides of a policy loan, including:

  • Your beneficiaries will get a lower death benefit if you die before paying back the loan.
  • The insurance company will charge interest on the loan.
  • If the outstanding loan balance is higher than your policy’s cash value, your policy will lapse. 
  • If the policy lapses, you’ll owe taxes on the borrowed amount and your beneficiaries won’t get a death benefit.

Borrowing Against Life Insurance: Should You Do It?

A life insurance policy loan gives you access to cash without going through a credit check or even giving a reason for why you need the money. Considering you can get lower interest rates than you would with most personal loans, the solution is appealing. But there are downsides, like having to pay interest.

If you don’t need your policy anymore, you may want to consider a life settlement instead.

FAQs About Life Insurance Policy Loans

Can You Borrow Against Life Insurance?

Yes, you can borrow against life insurance as long as your policy has cash value.

Do You Have to Pay Back a Policy Loan?

You don’t have to pay back a policy loan, but the insurance company will charge you interest. And if your loan balance (including interest) exceeds your cash value, eventually your policy will lapse.

Are Policy Loans Risk-Free?

Policy loans aren’t risk-free because if you don’t pay loans back, your death benefit will decrease or you could even lose your policy.

How Do I Know If My Life Insurance Has Cash Value?

To know if your life insurance has cash value, look at your life insurance statements for a cash value amount — it will be listed separately from other policy details.

Sell your life insurance policy for cash.

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We’re here to help. Speak with a Policy Specialist today at +1 848-456-8333