Concern can result from how much can I borrow from my life insurance policy? Whether a whole or universal policy? It is very possible to get against these two policy forms specifically because they accrue cash value regardless of the death benefit. How do they operate? Tag along to find out.
It is easy to take out a policy loan, but then How Much Can I Borrow from My Life Insurance Policy? There aren’t many requirements at all. Borrowing against life insurance can be a smart move for certain individuals, but it isn’t always the best idea.
Whole and universal life premiums are much higher than term life insurance, but a portion of each premium is placed in a special cash value fund.
Each time you make one of these premiums, the premium not only covers your insurance protection itself, but the excess amount is put into the cash value fund and invested.
This is different from the death benefit. After it has grown in value enough, you can borrow against it. It’s a common misconception that your cash value contributes to your death benefit. With most policies, this isn’t so. You can’t also borrow against the death benefit.
How a Policy Loan Works
Policy loans on life insurance policies are unlike bank loans in nearly every respect. Nevertheless, they’re all founded on the same basic principle: the lender is going to be repaid by the borrower with interest.
Apart from the underlying mechanism, policy loans and bank loans have different rules. You can take a loan from your cash value life insurance policy as soon as there is enough to borrow against.
It takes a few years to build value unless you’re overfunding the policy or own a single-pay policy. Account growth also depends on the interest rate it earns.
Whole life has a small, fixed, guaranteed interest rate. The cash value accumulates slowly and steadily. The interest rates for universal life insurance products, conversely, fluctuate according to the market.
How Much Can I Borrow?
Your cash value balance determines how much money you can borrow—typically, whatever you want or as little as you’d like. You can also borrow more than one loan if the borrowed funds are below your total cash value.
Unlike earlier loan policies, there are no mandatory repayment terms with policy loans. You won’t have to pay it back during your lifetime if you don’t want to. In no way is it a free loan, though. The amount does carry interest.
There are two ways of calculating the interest rate on a loan. A policy will have a fixed rate specified in the policy (e.g., 8%) or a market-based variable rate. In either case, rates are normally below any bank loan or credit card interest rate.
When you take a loan from your policy, the insurer loans you the money and uses your cash value as collateral. If you are not able to pay the loan back during your lifetime, the loan amount plus interest will be subtracted from your death benefit, essentially shortening the amount of money your beneficiaries receive.
In most cases, paying back the loan on top of your regular premiums is advisable to ensure your debt doesn’t grow beyond your control. Alternatively, some people just repay the accruing interest to keep the balance manageable.
How policy loans work:
- Part of each premium funds a separate account that grows due to compounding interest
- Carriers use the account’s cash value as loan collateral.
- If you fail to pay back the loan, the debt will be subtracted from the death benefit
You cannot borrow against term life insurance since it doesn’t build up cash value. Permanent life policies such as whole and universal do build up cash value, so you may borrow against them.
What does Each Policy Provide?
- Whole Life Insurance: Most common type of permanent life insurance. It comes with fixed premiums and guaranteed cash value.
- Universal Life (UL) Insurance: Adjustable premiums and death benefits but less guarantee. Also, it allows withdrawal of cash value.
It is better to borrow against your life insurance than take a bank loan or credit card loan. Why?
- Policy loans are given, no questions asked (as long as you have enough cash value)
- Policy loans are not disclosed and will not show up on your credit report
- Policy loans are faster to receive cash than a bank loan
- The IRS is not aware of policy loans, so they’re free from tax
- Policy loan rates of interest are typically lower than bank loans
- No repayment schedule is needed
- As with all loans, there are also disadvantages to be mindful of.
Cons:
- If you don’t repay the policy loan during your lifetime, the amount will be deducted from your death benefit
- Interest accumulates as long as there is an outstanding balance
- If your loan balance and accumulating interest ever surpass the cash value, the policy will lapse
- May owe tax if policy lapses
- Loans can decrease your policy’s dividends
- If a UL policy, borrowing against the policy can hurt some policy guarantees
Before you take out a policy loan, make sure you explore all avenues first. In the event your main reason for buying life insurance is to leave a death benefit to your dependents, you should not borrow against the policy.
Is there to Borrowing on a Policy?
Not really. If you borrow on a policy and don’t pay it back, you may lose the policy and incur tax charges, putting your family’s finances at risk, which is in direct opposition to the entire purpose of getting life insurance in the first place.
If you have a life insurance policy that builds cash value, you’re instantly qualified for a loan. Second, policy loans don’t entail a hard credit check that will further damage your credit. Also, policy loan rates are often lower than bank loans or credit cards.
What are the Uses of a Policy Loan?
If you’re an older person with financially independent adult children, you may prefer to use a policy loan to leave more benefit than to leave money to your heirs. Some uses are:
- To finance a child’s wedding
- To pay for a child’s college education
- To make a down payment on a home
- To cover an unexpected expense
- To fund a business venture
- To augment retirement income
How to Borrow Against Life Insurance
Taking out a loan against a life insurance policy is simple. No approval process, just some simple steps.
1. Call your Quotacy agent
They will locate your insurer’s form for you to complete.
2. Complete the form
You’ll have money in your account soon.
Policy loans are not your only option for accessing your cash value account funds. Instead of borrowing, you can simply withdraw, use your cash value to pay your premium, or surrender your policy for a payment.
What is the Policy Loan Feature All About?
In addition to the policy loan feature, universal life insurance policies have a withdrawal feature. A withdrawal is a permanent reduction from the cash value and death benefit on the policy. It can never be repaid.
You may withdraw up to the whole amount paid into the policy to date without paying taxes on it. Any amount over that may be taxed. There are some cash value products, like universal life insurance, where you can borrow from the cash value account to pay premiums.
But with a whole life policy, you can have automatic premium payment by way of policy loan if you happen to forget to send payment by mail. Such an arrangement is called an automatic policy loan.
Last Lines
If you do not wish to have life insurance, you can surrender a permanent policy for its cash surrender value. The payment, cash surrender value, is your policy’s total cash value less termination charges.
This may be a tempting option if your beneficiaries will not need the death benefit and your policy is old enough to have built up substantial value.
If your beneficiaries do not need your death benefit or you cannot secure a traditional loan, borrowing against a whole or universal life policy can be helpful. For more on permanent life rates and products, take our short questionnaire, and an agent will contact you.
