Chances are, if you bought a life insurance policy, you did so to protect your family from financial loss in case of your passing. But, did you know that you can borrow against certain types of life insurance policies? Let’s look at how it works and why you might want to consider doing so.
First, it’s important to understand that you can only borrow against a life insurance policy that allows you to do so. These types of policies are called ‘permanent’ or ‘cash value’ life insurance and they differ from term life insurance, which pays out only if the policyholder dies during the policy term. Permanent life insurance policies pay a death benefit no matter when you die. A portion of the premium you pay funds a separate account that builds up cash value. Depending on the permanent life insurance policy you have, this cash value may be a part of your death benefit, or in addition to it. You can also borrow a portion of this cash value. The amount you can borrow depends on the specifics of your policy.
Borrowing against a permanent life insurance policy offers advantages over traditional loans
While you should never enter into a loan agreement lightly (and borrowing against a life insurance policy is no exception), you may want to consider your loan options beyond banks and credit cards, if you’re low on funds and need to pay for a major expense. Taking the money you need out of a cash value life insurance policy offers several advantages including:
- No approvals are necessary. If you have enough cash value in your life insurance policy, you can borrow from it directly without having to go through an application process or a credit check. You complete a form and receive a payment—it’s as simple as that.
- Interest rates will likely be lower. Personal loans often have high interest rates so it’s likely that borrowing against your cash value life insurance policy, you’ll get a lower interest rate than by using a bank or a credit card company—plus, it won’t appear on your credit report.
- You can pay it back on your schedule. While you should repay any loan that you take out, when you borrow against a cash value or permanent life insurance policy, you can pay the money back on your schedule, rather than one determined by a bank or credit card company. One caveat, though, if your policy lapses before you fully repay the loan, you may end up owing taxes on some or all of the portion you haven’t paid back.
It pays to be informed before you borrow against a cash value insurance policy
Like any financial decision, you should be sure to educate yourself about the pros and cons of tapping into your cash value insurance policy for a loan. Some of the important things to consider before you act are:
- Your death benefit will be reduced—if you don’t repay your loan during your lifetime. This could put your family in a difficult financial position unless you have other assets to fall back on.
- Loans can only be made within the cash value amount of the policy. It takes years for permanent life insurance policies to provide significant cash value, so buying one now, won’t give you immediate access to “quick cash.” However, if you have a policy that’s more mature, you can borrow against it, subject to any specific parameters determined by the insurer.
- Your policy can lapse if you exceed its cash value. Life insurance policy loans tend to have lower interest rates, but interest still applies and is often simply subtracted from your cash value, so you need to be sure that you understand the full terms under which you are borrowing money. If the amount you borrow, plus interest, exceeds your policy’s cash value it may cause the policy to lapse and you could also face tax consequences.
The bottom line on borrowing against your cash value life insurance policy? If you need to cover an unexpected medical bill, or you’re worried about making a mortgage payment, a policy loan may be a better option than adding to a credit card balance or taking a higher interest bank loan. But make sure that you understand the conditions of repaying the loan, any reductions in your death benefit and the interest you will be charged so that you make a sound financial decision.
Our insurance professionals can help you determine if purchasing a new cash value policy or borrowing against an existing one is right for you. Contact us to learn more!
Kris Guerrero-Merkel is a member of the personal lines sales team at Kemner Iott Benz in Ann Arbor, MI. He enjoys watching Notre Dame and Chicago Bears football, but also has a soft spot for University of Michigan athletics. On the weekend, he can be found watching old movies or exploring any of Ann Arbor’s fine food establishments. He also enjoys cooking anything and everything under the sun, his potato soup is perfect for the cold winter months.