If you have a life insurance policy…congratulations; you’ve taken a bold step towards ensuring the financial security of your family and loved ones. But what if I told you that your policy could be monetized in a pretty unique way. That’s right, depending on the type of policy, you may be able to take out a loan against its value. Below we’re going to break down how it’s done, why you should (or shouldn’t) do it, and what are the consequences. (Please Note: The details of individual life insurance policies can differ significantly from company to another…even from person to person. It is important to consult a life insurance specialist before making any purchases of /changes to a life insurance policy.)
What is a Life Insurance Loan?
A life insurance loan is basically a loan taken out against the value of a life insurance policy. More specifically, it is a loan taken out against the type of life insurance that builds cash value, such as a whole life insurance policy. Policies that don’t build any kind of cash value, such as term life insurance, are generally ineligible for loans.
The cash value of the life insurance policy is the key to making a life insurance loan possible. Because the cash value is usually composed of your premium payments plus any interest; when you take out a loan against your policy you’re basically taking out a loan against yourself. Such a loan is typically low risk for your insurance company, which allows you to get a loan with some pretty unique advantages.
Advantages of A Life Insurance Loan:
Borrowing against your life insurance comes with many advantages over your typical loan. Let’s go over them one-by-one: First…
You are very, very unlikely to be turned down for a life insurance loan:
Legally, as long as your life insurance has a cash value to borrow against; you cannot be turned down for a loan against that amount. That’s right. Regardless of credit score, credit history or even (in some cases) criminal record; that loan is yours for the taking. And this makes sense since it’s your premium payments that have built up that cash value since the policy’s inception. Honestly, the only feasible way to be turned down is if you’ve already borrowed against your total cash value.
Favorable Interest Rates:
Here’s another big advantage. You can typically borrow against your life insurance at a rate significantly lower than the rates on other personal loans. According to LendingTree, in 2021 the average personal loan rate from U.S. banks was in the range of 9.4% to 22.16%. Meanwhile, the interest rate on life insurance loans has remained in the 5 – 9% range for more than a decade.
Repayment Terms are Lax:
This is another consequence of borrowing from your life insurance policy. Since, you are essentially, borrowing from yourself, the life insurance agency usually ends up giving you some pretty lax repayment terms. Some company’s do not even specify an exact repayment date or repayment interval (yearly, monthly, etc). They just make it clear that repayment must be made with interest for the policy to remain in effect.
Your Cash Value Keeps Growing:
This is probably the best advantage of having a life insurance loan. While you are borrowing against your policy’s cash value, that cash value is still growing and earning dividends. Some people take full advantage of this when the cash value in their policy is very high. Essentially, they use dividends from the cash value of their policy to pay off the interest accrued on the life insurance loan itself. Genius!
Disadvantages of A Life Insurance Loan:
Of course, this wouldn’t be a thorough analysis without looking at the other side of the coin. Failure to pay or comply with the specific rules and regulations surrounding life insurance loans can land you in some serious trouble. Let’s look at some common ways that this happens:
If you do not repay loan, you can definitely lose you all or part of your life insurance coverage:
This happens in mainly two ways. First, if the borrower dies before making a full repayment on the life insurance loan; the insurance company typically takes the following steps. They take the amount of the life insurance benefit and the deduct from it the loan amount. The balance is then given to beneficiaries.
Second, when you borrow against your life insurance and fail to make loan payments; the insurance company can then opt to take loan payments from the cash value of your policy. Yikes!!! If the cash value of you policy has been completely depleted by the loan payments, you will then lose your life insurance policy completely. No benefits, no payouts.
If you lose your policy from non-payment, you could be in for a hefty tax bill:
Borrowing from your life insurance is generally tax free. However, if your life insurance policy is cancelled from non-payment, that loan is now considered income in the eyes of the IRS and you will be taxed on it. How you will be taxed and at what rate will vary slightly depending on your policy and individual situation. Consult your insurance advisor to be absolutely sure of your tax liability.
How should you decide?
When you borrow against your life insurance policy, you should proceed carefully. Run through all the pros and cons, all the scenarios in your mind that may fill you with dread and doubt. Because although life insurance loans are incredible investment vehicles; they can potentially put your policy (and financial security) at risk if not handled properly. With that said, let’s run through a few scenarios to see if and when a life insurance loan makes sense.
You have no dependents (no beneficiary needed):
Let’s say you’ve had an insurance policy for many years. It’s original purpose was to provide a source of income for your kids should you every pass away. However, now your kids are all grown up with income and dependents of their own. Should you borrow against your policy.
All else being equal, yes this may be a good time to borrow against your policy. You’ve more than likely accumulated a hefty cash value on your policy. You could therefore take out a sizable loan while having the interest payments covered (or at least partially covered) by dividend payments. Additionally, if you should die before, repaying the loan amount; more than likely your death benefit will cover any outstanding balance.
You have a steady income / the ability to make regular payments:
If you are still working and are typically responsible with repayment plans, mortgages, etc; then a life insurance loan may be your best loan option on the market. As we mentioned before, these loans generally have more generous repayment terms, a low risk of loan denial and favorable interest rates compared to other market options.
You need money temporarily / For an emergency:
Each year i the U.S. hundreds of thousands of people fall into dire financial straits because an emergency expense wiped out their savings or emergency fund. However, by borrowing against your life insurance you can avoid becoming another statistic. Not only can you obtain the money that you need right away without too many barriers; but also your policy’s cash value will keep growing and earning passively. The best of both worlds.
I hope, we’ve answered all you questions regarding life insurance loans. For more detailed inquiries, please refer to your insurance company rep or insurance specialist. Until next time….make it rain!