Can You Borrow Against Life Insurance?
Borrowing against a life insurance policy is a great way to get the cash you need without having to jump through a lot of hoops. But if you’re thinking about borrowing against your life insurance policy, there are some things you should know about how the process works. For instance, if you’re asking, “Can I borrow against term life insurance?” the answer is no. But if you’re asking, “Can I borrow against a whole life policy?” the answer is probably so.
Here’s what you need to know to help you determine whether or not you can borrow against your life insurance policy.
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Can You Borrow Against a Whole Life Insurance Policy?
When determining whether or not you can borrow against your life insurance policy, you need to first understand the type of life insurance that you can borrow against. Some life insurance policies earn cash value, and those are the types of insurance policies you can borrow from. Whole life insurance and universal life insurance are both insurance policies that earn a cash value.
A cash value is accumulated over time. It is the amount of the policy that you would earn if you were to surrender the policy. Every time you make a premium payment on your policy, the insurance company will put a portion of it aside that goes towards the cash value. Over time, the cash value increases as it earns interest. The interest rate is set at the onset of the policy.
But not all insurance policies earn cash value. For instance, term insurance does not, so you cannot take out a loan on this type of policy. That’s because a term life policy is only a temporary policy, and the time is dictated by the “term” of the policy. It could be anywhere from one to 30 years, and once the term expires, the policy is no longer in effect.
How Much Can You Borrow Against Your Life Insurance Policy?
Are you wondering how much you can borrow against your life insurance policy? If you’ve figured out that you have an insurance policy with cash value, this is the next logical question. Depending on which insurance carrier you use, the answer will vary. But generally, the most you can borrow from your insurance policy is 90% of the cash value. There is no minimum amount that you can borrow.
That means if you have a final expenses life insurance policy with a $50,000 death benefit and the cash value of the policy is $30,000, you would be able to borrow 90% of that $20,000 - $18,000.
Here’s how it works: When you borrow money from your insurance policy, you are not decreasing the amount of its cash value. Instead, you are using the cash value as collateral for the loan. That’s good news because it means that the cash value will stay intact on the policy – and it will continue to collect interest.
And unlike a typical loan, you will not have a set time period in which to repay what you borrowed. But there are some things you should understand. For starters, if you don’t pay back the interest on your loan every year, that amount will be added to the outstanding balance of your loan. The interest can be fixed or adjustable, and it’s important to understand how each will play into your loan repayment. For instance, a fixed interest rate never changes, so you will know what to expect as far as interest payments. But an adjustable rate goes up and down in line with the prime interest rate, and if it goes up after you borrow the money, you will end up paying more in interest than you may have anticipated.
Secondly, you will have to ensure that your loan balance never exceeds the cash value of your life insurance policy. How could that happen? By not staying on top of the interest payments. Remember, there is interest on the money that you borrow, and that interest compounds over time. So, if you don’t make at least the minimum interest payments, the loan amount could overtake the cash value. And when that happens, your policy will lapse.
If you do take out the loan, you may be liable for taxes from the IRS. That’s because the loan is considered income and you may be asked to pay income taxes on it. You should speak to your financial advisor before taking out the loan to fully understand your tax liabilities.
Finally, you should understand that if you borrow money from your life insurance policy and don’t pay it back, the amount of the loan will be deducted from the death payout. And that means that your loved ones will not receive the money that you intended them to have.
| Pros and Cons of Taking a Loan Against Your Life Insurance Policy | |
| Pros | Cons |
| You have access to quick and easy cash | You risk the possibility of policy lapse if the loan exceeds cash value amount |
| You don’t have to qualify for the loan | You may owe taxes on the loan amount |
| Interest rates are typically low | If you don’t repay the loan, the death benefit will be reduced by the amount of the loan |
How Soon Can You Borrow Against Whole Life Insurance?
When thinking about borrowing money from a life insurance policy, many people ask, “How soon can I borrow against whole life insurance?” And that brings us back to the cash value of the policy. Remember, in most cases, you will be able to borrow up to 90% of the cash value of your insurance, but that means that a cash value must exist before you are eligible to borrow from it.
Depending on your life insurance policy and the interest rate that is paid on it, it will take five to 10 years to earn a cash value that is worth borrowing against. And for most people, it will be closer to 10 years rather than five.
Once you’re ready to take out a loan from your insurance policy, the process is simple. First, you will need to notify your insurance company of your intent. It will ask you to fill out a form that you must submit to them. After that, the money will typically be deposited into your bank account in a few days.
There are some instances when you may have to do more, such as when you change the ownership of a policy, you added new account information to the policy, or when you go over the specific amount of loan dictated by the insurance company. In these instances, you may be asked to:
- Confirm your identity
- Sign a document confirming who you are and your intent for the loan
- Have a notary confirm your identity
Life Insurance That You Can Borrow Against
Remember every life insurance policy isn’t set up to allow you to borrow from it. Some life insurance policies fall under the term “permanent,” which means the policy will remain in place for your entire life as long as you continue to pay the premiums. The policies that fall under this term are the types that will allow you to borrow from them.
On the other hand, term life insurance policies – those meant to only be in effect for a term – do not build a cash value, so you cannot borrow from them.
| Can I Borrow From My Life Insurance Policy? | |
| You CAN borrow from: | You CAN NOT borrow from: |
| Burial Insurance, also known as final expense insurance with a cash value | Burial insurance, also known as final expense insurance without a cash value |
| Whole life, also known as ordinary life | Term life insurance |
| Variable life | |
| Variable universal life | |
| Universal also known as adjustable life | |
If you think that, in the future, you may want to have access to life insurance that will allow you to borrow from it, you should seriously consider getting permanent life insurance or one of the types of life insurance policies listed in the chart above.
Do You Need to Borrow Money From Your Life Insurance Policy?
If you currently have a life insurance policy with cash value and want to borrow from it, it’s easy to do. Simply reach out to your insurance provider and ask them about the process. On the other hand, if you are thinking about getting life insurance and want to consider a policy that comes with a cash value, be sure to speak to representatives from each type of insurance. For instance, if you anticipate needing a large loan, you should speak to an insurer who will issue a large death benefit so you will have more cash value to work with. But if you anticipate only needing a small loan or two, a burial insurance policy is probably right for you.