If you’re one of the 51% of Americans with life insurance coverage, you might consider borrowing against your policy if you need quick access to cash. If you're eligible, a life insurance policy loan might be right for you.
Borrowing against your life insurance policy differs significantly from traditional unsecured loans. Typically, unsecured loans require a credit check to assess eligibility and determine interest rates. In contrast, life insurance policy loans do not involve a credit check, as the policy's cash value serves as collateral.
Borrowing against your life insurance doesn’t require a credit check or a strict repayment schedule, making it a fast and flexible option. If you want to avoid tying up other assets or waiting for approval, you can access funds quickly. Plus, these loans often come with lower interest rates than unsecured loans. Let’s break down the process.
How to get a life insurance policy loan
There are different types of life insurance, so you'll need to ensure your policy is eligible before borrowing against it. You can only borrow from permanent life insurance policies, like whole or universal life. You can’t take out a life insurance policy loan if you have term life insurance. That’s because term life insurance doesn’t have a cash value component like permanent policies.
Remember, you’re borrowing something you eventually have to repay and that has a cash value. Because term policies don’t hold the same value, there’s no option to borrow loans from these types of insurance policies.
You can request a loan from your life insurance provider without providing a reason for why you need your funds. But keep in mind your insurer sets the limit on how much you can borrow, which is usually no more than 90% of the policy’s cash value. While that sounds like a lot, it could take years for your account to have that much value to borrow the full amount.
It’s important to note, that if a life insurance policy lapses due to an unpaid loan exceeding its cash value, the policyholder may face tax consequences. The amount by which the loan surpasses the total premiums paid (known as the cost basis) is considered taxable income. This means that without receiving any actual cash upon the policy's lapse, the policyholder could incur a tax liability based on the policy's gains.
Use our tool below, in partnership with Bankrate, and explore your life insurance options today:
Pros and cons of borrowing from your life insurance
Like every loan, there are pros and cons to borrowing against your life insurance policy. It might be worth it if you need to borrow money, but it’s not without its risks.
Pros
- No credit check or approval process. Request the loan from your insurance provider, and as long as your policy has enough cash value, you’ll receive your funds.
- Casual repayment. Often the timeline for repaying your loan is flexible. Policyholders are expected to pay back the interest and principal in their lifetime. If you don’t make payments on your loan, you won’t face a drop in credit score or repossession of your assets.
- No taxes. In most cases, life insurance policy loans don’t get taxed as income. You wouldn't owe income tax when you borrow from your life insurance policy. However, if the policy lapses or is classified as a Modified Endowment Contract (MEC), taxes may apply.
Cons
- There’s still interest. Like any loan, you’re still on the hook for interest. While you don’t have any structured repayment plan, the longer you go without paying back your loan, the more interest will eat away at your policy’s cash value.
- Decrease in benefits. If you die before your loan gets repaid, the amount your beneficiaries get goes down. Your loan and any interest get repaid to your insurer before the death benefit payout.
- You could lose coverage. If you go long without paying back your loan, your cash value may get low enough that you’ll owe more than the plan is worth. There’s a chance you could face fines or fees from your insurance provider or your policy could be terminated.
The bottom line
If you need money now and have an eligible life insurance policy, borrowing money from yours might be a good idea. You’ll get money relatively quickly without going through the normal hoops of a traditional loan. You get to repay your loan on your own time, so you don’t risk your credit score dropping if you can’t afford to make payments on time.
Given the complexities and potential risks, consulting with a financial adviser is recommended if you’re having trouble deciding the best path forward. They can provide personalized guidance based on your financial situation and goals, helping you make an informed decision. Borrowing from your life insurance isn’t risk-free. Consider the long-term impacts of borrowing a life insurance policy loan to see if it’s the right choice for you.
