Life insurance is an essential tool for families and individuals to secure their future financially. It provides financial support to the family in case of the untimely demise of the insured. However, life insurance policies can do more than just cover the risk of death. They can be used as collateral for loans, and in some cases, life insurance policies can be borrowed against. In this article, we will discuss borrowing from life insurance policies, the types of policies that can be borrowed against, and the pros and cons of such borrowing.
What is Borrowing from Life Insurance?
Borrowing from life insurance policies is a way to access the cash value in a policy. When you make premium payments for a life insurance policy, a portion of that money goes towards building cash value in the policy. The cash value grows over time, and you can borrow against that value. When you borrow against the cash value of a life insurance policy, you are essentially borrowing from yourself, and the policy serves as collateral for the loan.
Types of Life Insurance Policies that can be Borrowed Against
Not all life insurance policies can be borrowed against. The following types of policies can be borrowed against:
Whole Life Insurance
A permanent life insurance policy that builds cash value over time, and premiums remain the same throughout the policy’s life.
Universal Life Insurance
A permanent life insurance policy that allows flexibility in premium payments and the death benefit.
Variable Life Insurance
A permanent life insurance policy that allows the policyholder to invest the cash value in various investment options.
Term life insurance policies do not have cash values and cannot be borrowed against.
The Pros and Cons of Borrowing from Life Insurance
There are a few advantages to borrowing from a life insurance policy:
The interest rate on a life insurance policy loan is typically lower than the rate on a traditional loan. The reason for this is that the policy serves as collateral, reducing the lender’s risk.
No Credit Check
Since you are borrowing against your own policy, there is no need for a credit check or collateral.
Policy loans are not considered taxable income, and the interest paid on the loan is tax-deductible.
No Repayment Schedule
When you borrow against a life insurance policy, there is no set repayment schedule. You can pay back the loan at your own pace, and the loan balance will accrue interest until it is paid off.
While there are some advantages to borrowing from a life insurance policy, there are also some drawbacks:
Reduced Death Benefit
Borrowing against a life insurance policy reduces the death benefit. If the loan is not repaid, the balance plus interest will be deducted from the death benefit.
Reduced Cash Value
When you borrow against a life insurance policy, the cash value is reduced, and it can take years to rebuild the value.
If the loan balance plus interest exceeds the cash value of the policy, the policy may be cancelled, and the insured may have to reapply for coverage.
Not Ideal for Short-Term Needs
Borrowing from a life insurance policy is not an ideal solution for short-term needs since it can take several weeks to process the loan.
Frequently Asked Questions
1. How much can I borrow from my life insurance policy?
The amount you can borrow from your life insurance policy depends on the cash value of the policy. Typically, you can borrow up to 90% of the cash value.
2. Can I borrow from a term life insurance policy?
No. Term life insurance policies do not have a cash value, so they cannot be borrowed against.
3. Do I have to pay back the loan?
Yes. You must pay back the loan with interest. If you do not repay the loan, the balance plus interest will be deducted from the death benefit.
4. Can I use the loan for any purpose?
Yes, you can use the loan for any purpose, such as paying off debt, making a large purchase, or covering unexpected expenses.
5. Can I borrow against a group life insurance policy?
No. Group life insurance policies are not typically portable, so you cannot borrow against them.
Borrowing from a life insurance policy can be an attractive option for those looking for a low-interest loan. However, it is important to consider the pros and cons and understand the impact it can have on the policy’s cash value and death benefit. If you are considering borrowing against a life insurance policy, it is advisable to talk to a financial advisor or insurance agent to discuss your options and determine the best course of action for your individual needs.