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Is it worth borrowing against my life insurance policy?
A cash value loan could pay off your mortgage or your kids’ tuition — but it has consequences.
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One of the major benefits of buying a permanent life insurance policy is the cash value growth. Once you’ve accumulated enough cash value, you can take out life insurance loans against your own policy. But doing this will reduce the death benefit of your policy — which means your loved ones might not receive as much money as you intended.
What's in this guide?
What does it mean to borrow from my life insurance?
Permanent life insurance policies — like whole life and universal life — build up cash value that earns interest over time and grows without additional taxes. When you’ve built up enough cash value, you can start dipping into the cash value — and your insurance company uses the policy as collateral for the loan.
You can spend the money however you like. Many people use the cash value to supplement their retirement income, settle their debts, and pay off major expenses, such as a mortgage, college tuition.
Do I have to borrow the entire cash value amount?
No. To keep your policy active, only take out a partial amount of the total cash value. Alternatively, if you no longer need life insurance, you can surrender the policy and collect the cash value.
How do I borrow against my life insurance policy?
To take out a life insurance loan, you’ll need to contact your insurer and fill out some forms. The process varies, but these are the general steps:
- Verify you have enough cash value to take out a loan.
- Contact your insurance company to get the necessary forms to complete.
- Determine the payout method for your loan.
- Monitor your loan balance to keep up with loan payments.
How can I figure out if I have enough cash value to take out a loan?
When you buy a permanent life insurance policy, you will receive a copy of your policy. The policy will include a chart showing the projected growth of your cash value over time. This is where you will see how much money you’ve built up.
However, those numbers are just projections based on average interest rates, so you will need to contact your insurance company to find out exactly how much money you have available in cash value.
Is there a waiting period to take out a life insurance loan?
No. However, since cash value grows slowly at first, it might take some time before you can borrow against it.
There can be anywhere from a three to 10-year delay between when the policy starts and building enough cash value to borrow from. Each insurance company has slightly different policies and procedures for this. The time will depend on the size of your policy and the amount of premium you pay each year, with lower premiums taking longer to accumulate cash value.
How much can I borrow against my life insurance policy?
You can borrow up to the amount of cash value that has accumulated. If you have $100,000 cash value that has built up, then you can take out up to $100,000.
Permanent life insurance policies contain a cash value chart that shows you how much cash is expected to accumulate over time, each line in the chart shows the number of years the policy holder has the policy and its corresponding cash value.
Do I have to pay back the loan?
No, you have no obligation to repay the loan. But if you don’t, your insurer will subtract the amount of the loan from the final death benefit paid out to your beneficiaries.
What is an overloan protection rider?
An overloan protection rider prevents your policy from lapsing. Offered by many insurers, it sets aside part of the death benefit so it can’t be touched by loan payments that come out of your policy’s cash value.
There are a few caveats. Typically, the rider only kicks in once you’re 75 or older, and your policy has been in force for 15 years. You’ll have also needed to accumulate a certain amount of cash value — like $100,000.
MUST READ: What should I know before borrowing against my policy?
Borrowing against your life insurance policy can impact your beneficiaries. If you don’t pay it back before you die, your insurer will take the money out of the death benefit. And if you borrowed your entire cash value, this means your beneficiaries could be left with nothing — which would totally void the life insurance aspect of your policy.
There are some situations where this might be the intended consequence, such as if your beneficiaries don’t need the money anymore. But you should be fully aware of the impact of taking out your cash value before you make a move.
Pros and cons of a life insurance loan
Pros
- Doesn’t show up on your credit score
- No loan application, credit check or providing financial statements
- Does not count as taxable income
- Interest rates are lower than a traditional loan
- Paying the loan back is optional and can be done on your own schedule
Cons
- Cash value is slow to grow, so it could take many years before taking out a loan is an option
- Your death benefit could be reduced if your loan isn’t repaid while you’re living
- If the amount of interest in addition to the unpaid loans are more than the policy’s remaining cash value, you could lose your policy
- If the policy lapses before you repay your loan, you could owe income taxes on the loan amount
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When to consider taking out a policy loan
Borrowing against your policy might make sense in these situations:
- You’re not eligible for a standard loan. If you have a poor credit history working against you, a policy loan could be a viable option. As long as you have enough accumulated cash value, you’ll be approved for a policy loan — and it won’t harm your credit score.
- You want a flexible repayment schedule. With traditional loans, lenders typically require you to stick to a strict repayment schedule. On the other hand, policy loans don’t have such a schedule, so you can pay back your loan as it suits you. Just keep in mind that if you don’t make timely payments, you could risk losing your coverage.
- You need cash, but don’t want to risk your other assets. Many traditional lenders will only grant you a loan if you put up another asset — like your home — as collateral. If you don’t make your repayments, it has the right to acquire that asset. With policy loans, failing to pay puts your coverage and your beneficiaries’ death benefit at risk — but not any tangible assets.
When to avoid taking out a policy loan
You might want to explore other borrowing options if:
- You can’t afford to repay the loan. While you don’t have to pay back the loan, if you die, your insurer will dip into the death benefit to cover the cost. This means your beneficiaries won’t receive the full amount of money you intended to leave them.
- You have a variable life insurance policy. A portion of the cash value is invested in the stocks, bonds and mutual funds of your choice — and the money is also subject to the ups and downs of the market. But if you take out a loan against your variable life policy, you could end up paying more interest than you would if you borrowed from a different type of permanent policy, like whole life. Your insurer might charge you an “opportunity fee,” which is the difference between your interest payments and the interest your premiums were earning when they were being invested.
Can I cash in my policy instead?
It depends. If you’ve built up enough cash value and no longer need life insurance, you can surrender your permanent policy and collect the money. This is known as a cash surrender. However, you’ll probably have to pay fees — especially if you cancel within the first 10 to 20 years of taking out the policy. You’ll walk away with the “cash surrender value,” which is the cash value minus any fees and loans you’ve taken out against your policy. The longer you owned your policy, the more money you’ll get.
Does term life insurance have a cash value to borrow against?
No, there is no cash value growth in a term life policy. Term life policies are strictly life insurance with no extra uses. If you die within the term, your beneficiaries will receive a guaranteed death benefit. However, you may be able to convert your term life policy to a permanent policy if you meet certain criteria.
Since term life insurance is temporary and doesn’t have a cash value component, it’s also the most straightforward and affordable type of coverage. For these reasons, it’s sufficient for most people.
Bottom line
Borrowing against your life insurance policy is a benefit of permanent life insurance, but there can be consequences. Before using your cash value, consider speaking with an adviser to fully understand if this option is best for you.
If you decide to move forward with a policy, compare life insurance providers to find one that best suits your budget and needs.
Frequently asked questions about life insurance cash value
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