Leveraging Your Life Insurance: A Comprehensive Guide to Policy Loans

Life Insurance Loans
Borrowing against your life insurance policy can be a strategic financial move. This comprehensive guide will explore how policy loans work, why they can be a beneficial alternative to traditional loans, and considerations you need to keep in mind. Get the insights you need to make informed decisions about your financial future.
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Leveraging Your Life Insurance: A Comprehensive Guide to Policy Loans

What is a Life Insurance Loan?

A life insurance loan is a loan against a permanent life insurance policy. Whole life insurance allows the policyholder to have the amount of death benefit that the relatives of the policyholder will receive in the event of their death and cash value against which it is possible to take a loan. Part of premium payments goes to the death benefit, and the other part goes to the cash value. If the policyholder has accumulated sufficient cash value to take out a loan, then when contacting the insurance company, this cash value becomes collateral. If the borrower has problems paying the loan, then the amount that the borrower took from the insurance company deducts from the death benefit and takes it away.

Life insurance policy loans may be suitable for borrowers who can not be qualified for another loan. This may be due to poor credit or insufficient income. The borrower may urgently need funds to pay medical bills or other emergency expenses. Here, suppose the borrower has a life insurance policy. In that case, a life insurance loan may be the only option to get immediate funds without a credit check and income level verification.

There may also be situations in which the borrower cannot pay premiums under the life insurance policy. Whole life insurance requires payments to maintain insurance. If the borrower cannot make the insurance payment, then it lapses. In such situations, to avoid losing the life insurance policy, the borrower can borrow money against the cash value and on-time make premiums paid on.

Any traditional loan usually has a higher interest rate than a loan against cash value life insurance. For some borrowers, a smaller overpayment on interest may be a good reason to consider this loan as the only profitable financing option.

Features

  • Loan Availability. Life insurance loans are available to policyholders who have a cash value component in their permanent life insurance policies, such as whole life or universal life insurance. Term life insurance policies do not have a cash value and therefore do not offer this feature.

  • Borrowing Limit. The cash value of your life insurance policy determines the maximum loan amount you can borrow. Typically, policyholders can borrow up to a certain percentage (e.g., 90%) of the cash value.

  • No Credit Checks. Life insurance loans do not require a credit check because the policy's cash value secures them. The policy serves as collateral for the loan, so your credit history does not impact your eligibility.

  • Quick and Easy Access. Life insurance loans are relatively quick and easy to access. The policyholder can request a loan directly from the insurance company, usually by submitting a loan application form. Once approved, the funds can be disbursed promptly.

  • Interest Rates. Life insurance loans generally have lower interest rates than other loans, such as personal loans or credit cards. The interest rates are typically fixed and may be lower than market rates.

  • Repayment Flexibility. Policyholders have flexibility in repaying the loan. They can choose to make regular payments of principal and interest, pay only the interest, or defer the repayment altogether. Unpaid interest is often added to the loan balance, increasing the outstanding amount.

  • Tax Implications. Life insurance loans are typically tax-free, meaning the borrowed amount is not considered taxable income. However, if the policy lapses or is surrendered with an outstanding loan balance, taxes may be due on the loan amount exceeding the premiums paid.

  • No Mandatory Repayment. Unlike traditional loans, life insurance loans do not have a mandatory repayment schedule. If the policyholder does not repay the loan during their lifetime, the outstanding balance is deducted from the policy's death benefit upon their death.

  • Policy Continuation. The life insurance policy remains in force even if a loan is taken against it. However, the outstanding loan balance and any accrued interest will reduce the policy's cash value and death benefit until the loan is repaid.

  • No Effect on Credit Score. Since life insurance loans do not involve credit checks or reporting to credit bureaus, they do not impact your credit score positively or negatively.

  • Legal Regulations. Like other secured personal loans, life insurance policy loans are regulated by the Consumer Financial Protection Bureau (CFPB). This state organization regulates and controls the activities of banks, credit unions, and other financial institutions. The organization's main goal is to ensure that financial institutions, including those that issue loans, don't violate financial laws and conduct only honest activities without fraud and deception. If the borrower has any complaint regarding financing, credit cards, mortgages, or personal loans, the CFPB helps to deliver the complaint to the company and get a response to it. The CFPB ensures that every financial institution treats all borrowers equally and suppresses any discrimination on any grounds.

    The National Association of Insurance Commissioners (NAIC) recently enacted Actuarial Guideline 49, which includes an interest rates control point for cash value life insurance policy loans. According to this legal act, the maximum interest rate that can be set for this loan should not exceed 7%.

Pros and Cons of life Insurance Loans

Pros

  • The straightforward process of obtaining a loan. Since a life insurance loan is a collateral loan that is guaranteed by the borrower's assets, obtaining a loan is simplified. Usually, lenders don't make a credit check and don't check the borrower's income level. To get such a loan, the borrower only needs to have a cash value slightly higher than a certain threshold. Some online lenders have even automated this process, so the borrower doesn't need to wait for approval.

  • Life insurance loans will cost the borrower cheaper than other loans. A life insurance policy loan is a secured loan, so the interest rate for such a loan is lower. The high-interest rate in other loans is most often associated with the high risk that the lender has by issuing a loan to the borrower without collateral. Here, the borrower's insolvency is guaranteed by valuable collateral, so such a loan has less risk for the lender. Usually, life insurance policy loans have not too large fees and closing costs. Also, such loans are usually not subject to additional taxes.

  • Funds can be used. The borrower can use the received loan balance from the life insurance policy loan as they want. Where the borrower spends the funds received is not important for the lender since a cash value component, valuable collateral, guarantees the loan. The borrower can spend the funds received on home repairs, vacations, or emergency expenses.

  • Flexible loan repayment period. Unlike a traditional loan in which the borrower pays equal monthly payments, a life insurance policy loan doesn't have a clear loan repayment schedule. The borrower can pay the entire loan amount within two months or may pay nothing for several years. The borrower doesn't have a deadline for the payment of this loan. The borrower needs to remember that if there is an outstanding loan after the borrower's death, the loan amount plus the accumulated interest will be deducted from their death benefit.

Cons

  • The longer the borrower doesn't pay the loan, the more interest accumulates. If the borrower takes too long to pay off the loan, then a large amount of interest may accumulate by the time they want to pay it. Interest accrues throughout the entire time, from the moment of taking out the loan until its full repayment. It is more profitable for the borrower to pay off the loan as soon as possible since a quick repayment of the loan will ensure less overpayment on interest.

  • Risk of loss of insurance policy and death benefit. The most important drawback of any secured loan is the risk of losing what plays the role of collateral. Here, it can be life insurance cash value or death benefit. If the borrower cannot repay the loan, the amount that the life insurance company issued to them is withdrawn from the policy's death benefit. The borrower's beneficiaries at their death either receive a much smaller amount than they should according to the terms of whole life insurance or don't receive any compensation.

  • If the borrower's debt exceeds the cash value, taxes will be added to the amount of debt. Policy lapses if the accumulated loan interest, besides the loan balance, exceeds the borrower's death benefit. With policy lapse, the entire principal and interest amounts will be considered income by the IRS and taxed. If the borrower delays paying off the loan too much, this loan may come out much more expensive than expected. Therefore, before borrowing money, the borrower needs to approach the loan repayment plan responsibly.

How to get a Life Insurance Loan

A loan against life insurance has the simplest requirements among all personal loans.

Some borrowers receive life insurance policy loans directly from their own life insurance companies, so obtaining a loan becomes even easier. Such a loan has no requirements for the credit score and the borrower's income level, therefore, a potential borrower doesn't need to prepare documents confirming income and doesn't need to provide his SSN or ITIN. Also, the borrower's eligibility doesn't depend on the state of health.

As with any personal loan, a potential borrower must: 

  • Be at least 18 years old

  • A citizen or permanent resident of the United States

  • Upload identity documents such as a driver's license, passport, or state-issued ID.

Sometimes, the borrower may also need to notarize the existence of a life insurance policy. This may be required if the insurance policy has recently changed ownership, the loan exceeds a certain amount, most often $50,000, or if some personal information in the insurance has been changed in the last month.

To apply for such a loan online, the borrower needs to go to the lender's website and click on the "Apply Now" or "Get Started" button. Next, they need to enter personal information such as name, phone number, email, age, residential address, state, and ZIP code. After that, the potential borrower needs to enter the amount of benefit payout, a health condition that can be healthy, average, minor, or terminal. They also need to choose which type of life insurance policy they have. Most lenders have an automatic application verification process, so approval should come almost instantly.

Requirements and Conditions

  • Policy Type. Life insurance loans are available only for permanent life insurance policies that have a cash value component, such as whole life or universal life insurance. Term life insurance policies do not accumulate cash value and, therefore, do not offer this feature.

  • Cash Value Accumulation. To be eligible for a life insurance loan, your policy must have accumulated sufficient cash value. The cash value grows over time as you pay premiums and earn interest or investment returns. The loan amount you can access is typically a percentage of the available cash value.

  • Loan Application. To obtain a life insurance loan, you need to submit a loan application to your insurance company. The application may require details such as the desired loan amount, purpose of the loan, and repayment preferences. The insurance company will review and approve the loan request based on the policy's terms and conditions.

  • Loan Amount Limit. The maximum loan amount you can borrow is typically a percentage of your policy's cash value. The specific limit may vary depending on the insurance company and the policy terms. Generally, policyholders can borrow up to 90% of the cash value, but this can vary.

  • Loan Interest Rate. Life insurance loans generally have an interest rate associated with them. The interest rate is set by the insurance company and may be fixed or variable. It is typically lower than the interest rates of other loan types, such as personal loans or credit cards.

  • 6. Repayment Options. Policyholders have flexibility in repaying the loan. You can choose to make regular payments of principal and interest, pay only the interest, or defer the repayment altogether. Unpaid interest is often added to the loan balance, increasing the outstanding amount.

  • Tax Implications. Life insurance loans are generally tax-free, meaning the borrowed amount is not considered taxable income. However, it's important to note that if the policy lapses or is surrendered with an outstanding loan balance, taxes may be due on the loan amount exceeding the premiums paid.

  • Policy Continuation. Taking a life insurance loan does not affect the continuity of your life insurance policy. The policy remains in force, but the outstanding loan balance, along with any accrued interest, reduces the policy's cash value and death benefit until the loan is repaid.

  • Loan Repayment Priority. When you repay a life insurance loan, the payments are typically applied to interest first and then to the principal amount. It's essential to understand the repayment structure and how it affects the loan balance over time.

  • Loan Collateral. Life insurance loans are secured by the cash value of your life insurance policy. The policy serves as collateral for the loan, providing security for the insurance company. If you fail to repay the loan, the insurance company can deduct the outstanding balance from the policy's cash value or death benefit.

Best Places to get a Life Insurance Loan

Apply for a loan

  • Insurance Companies. The first place to explore for a life insurance loan is your insurance company itself. Many insurance providers offer life insurance policies with cash value components and loan provisions. Examples of insurance companies that offer life insurance loans include Northwestern Mutual and New York Life.

  • Banks and Credit Unions. Some banks and credit unions also offer life insurance loans. These financial institutions may have specific loan products designed to leverage the cash value in life insurance policies. Examples of banks and credit unions that offer life insurance loans include Wells Fargo and Navy Federal Credit Union.

  • Online Lenders. With the rise of online lending platforms, you can explore digital lenders that specialize in life insurance loans. These lenders may offer competitive rates and convenient application processes. Examples of online lenders that provide life insurance loans include Sproutt and PolicyGenius.

  • Financial Institutions with Specialized Products. Certain financial institutions focus specifically on life insurance loans and offer tailored solutions for policyholders. Examples of institutions specializing in life insurance loans include Life Credit Company and LendingUSA.

Ways to Receive the Money

  • Lump Sum Disbursement. The most common method is to receive the loan amount as a lump sum payment. Once your loan application is approved, the insurance company will disburse the entire loan amount to you in one payment. You can then utilize the funds as needed.

  • Electronic Funds Transfer (EFT). Another option is to have the loan amount directly deposited into your bank account through electronic funds transfer. This method allows for quick and convenient access to the funds, and you can easily transfer the money to other accounts or use it for your intended purposes.

  • Check or Draft. Some insurance companies may issue a physical check or draft for the loan amount. You can then deposit or cash the check at your bank or financial institution. This method provides a tangible form of payment, which can be beneficial if you prefer or require a physical check.

Things to Pay Attention to

When choosing a suitable loan offer and a suitable lender, the borrower should consider several important factors.

The interest rate is the most important factor to consider when choosing a life insurance loan. Most lenders that issue life insurance policy loans offer interest rates lower than any personal loan, but all lenders offer different interest rates. This is especially important to consider for a borrower who plans to pay off the loan for a long time, since interest accumulates until the loan is fully repaid. Landers can offer fixed rates and variable rates. Variable interest rates can allow the borrower to have an annual interest rate below the initial one. If the borrower values stability and doesn't want to have the risk of increasing interest rates, then they should choose a fixed-rate loan.

The borrower should also consider what additional fees the lender requires. These fees can be application fees, closing costs, and others. The size of the fee data will eventually affect the total amount of debt and the borrower should look for a lender who either has small fees or doesn't have them at all.

Another important aspect for the borrower to consider is the loan-to-value ratio. The Loan-to-value (LTV) ratio determines what percentage of the cash value amount the borrower can borrow. The best life insurance loan lenders have a loan-to-value (LTV) ratio of 90% to 95%.

To choose the right lender, the borrower can contact the financial advisor who will offer assistance in choosing the best loan solution.

How to Repay a Life Insurance Loan

  • Understand the Loan Terms. Familiarize yourself with the loan terms and conditions provided by your insurance company. Review the loan agreement, including the interest rate, repayment options, and any fees associated with the loan.

  • Determine Repayment Method. Decide on the repayment method that best suits your financial situation. Generally, there are three common repayment options available.

a. Regular Payments: Make regular principal and interest payments over a specified period to reduce the outstanding loan balance and interest charges.

b. Interest-Only Payments: Pay only the interest amount due on the loan, maintaining a lower monthly payment but without reducing the principal balance.

c. Deferred Repayment: Choose to defer repayment entirely, allowing the loan balance to increase over time due to accrued interest.

  • Set a Repayment Schedule. If you opt for regular payments, establish a repayment schedule that aligns with your financial goals. Determine the frequency and amount of each payment.

  • Automatic Payments. Consider setting up automatic payments with your bank or insurance company to ensure timely repayment and avoid late fees.

  • Additional Payments. If feasible, make extra payments towards the loan principal to expedite repayment and reduce interest charges.

  • Stay Informed. Monitor your loan balance, payments made, and any changes in interest rates. Regularly review statements and policy documents for accuracy and track your progress.

  • Seek Professional Guidance. Consult your insurance agent or financial advisor for personalized advice regarding loan repayment strategies and any questions or concerns you may have.

  • Monitor Policy Performance. Evaluate the impact of the loan on your life insurance policy's cash value and death benefit. Understand how the loan balance affects the policy's overall performance and adjust your repayment strategy if necessary.

Alternatives

  • Personal Loans. Personal loans are unsecured loans that can be used for various purposes. They are typically offered by banks, credit unions, and online lenders. Personal loans provide a lump sum amount that you repay over a fixed term with interest.

  • Home Equity Loans or Lines of Credit. If you own a home and have equity built up, you can consider utilizing a home equity loan or line of credit. These loans use your home as collateral and offer competitive interest rates. The loan amount depends on the equity you have in your property.

  • Credit Cards. Credit cards provide a revolving line of credit that you can use for purchases and cash advances. They offer convenience and flexibility, but it's important to manage credit card debt responsibly due to higher interest rates.

  • Home Equity Conversion Mortgage (HECM). Also known as a reverse mortgage, an HECM allows homeowners aged 62 and older to convert a portion of their home equity into loan proceeds. The loan does not require monthly repayments and is typically repaid when the homeowner sells the property or passes away.

  • Retirement Account Loans. Some retirement plans, such as 401(k)s or IRAs, may allow you to borrow against your account balance. However, it's important to consider the potential long-term implications on your retirement savings and any tax consequences.

  • Personal Lines of Credit. Similar to a credit card, a personal line of credit provides you with access to funds up to a certain limit. You can withdraw funds as needed and only pay interest on the amount borrowed.

  • Peer-to-Peer Lending. Peer-to-peer lending platforms connect borrowers with individual investors who are willing to lend money. These platforms often offer competitive rates and streamlined application processes.

  • Cash-Out Refinancing. If you own a property with a mortgage, you may consider cash-out refinancing. This involves replacing your existing mortgage with a new one that has a higher loan amount, allowing you to receive the difference in cash.

Editorial Opinion

Insurance loans have gained popularity as a convenient financial option for individuals seeking quick access to funds while leveraging their life insurance policies. However, like any financial product, insurance loans come with both advantages and considerations. In this opinion piece, we will explore the benefits and potential drawbacks of insurance loans, allowing readers to make informed decisions about their financial strategies.

One significant advantage of insurance loans is their accessibility. Unlike traditional loans, insurance loans do not require credit checks, making them accessible to individuals with varying credit histories. This can be particularly beneficial for those who may face challenges in obtaining loans from other sources. Additionally, the loan approval process for insurance loans is often quicker and more streamlined compared to traditional lending methods, providing borrowers with prompt access to the funds they need.

Another advantage of insurance loans is the potential for lower interest rates. Insurance companies often offer competitive rates for policyholders borrowing against their life insurance policies. These lower rates can result in considerable savings over time compared to other credit products, such as personal loans or credit cards. The ability to secure a loan at a favorable interest rate can be financially advantageous for individuals in need of immediate funds.

However, it is crucial to consider the potential drawbacks of insurance loans. One significant consideration is the impact on the policy's death benefit. When borrowing against a life insurance policy, the outstanding loan balance reduces the death benefit that beneficiaries would receive upon the policyholder's passing. It is essential to evaluate the long-term implications of this reduction and weigh it against the immediate financial needs being addressed through the loan.

Additionally, borrowers must be mindful of loan repayment responsibilities. Failure to repay the loan can lead to the policy lapsing or being terminated, potentially resulting in financial losses. It is essential to carefully assess one's ability to meet the loan repayment terms and ensure that the benefits of the loan outweigh the potential risks. Seeking guidance from a financial advisor can help in making an informed decision about insurance loans and incorporating them effectively into a comprehensive financial plan.

Insurance loans offer a convenient and accessible way for individuals to access funds while leveraging the value of their life insurance policies. The lower interest rates and simplified approval processes can be attractive features for borrowers. However, it is vital to consider the impact on the policy's death benefit and diligently fulfill repayment obligations. By carefully weighing the benefits and considerations, individuals can make well-informed decisions regarding insurance loans as part of their financial strategies.

FAQ

How much money can I borrow from my life insurance?

The amount that the borrower can take against their life insurance cash value is determined by the loan-to-value (LTV) ratio. Each life insurance loan lender sets a different loan-to-value (LTV) ratio. Usually, lenders offer the borrower the opportunity to borrow from 90% to 95% of their cash value. When the borrower receives a loan, the cash value account, which is something similar to the savings account for life insurance, is not emptied.

Do life insurance companies provide loans?

Yes, life insurance companies are engaged in issuing loans against life insurance policies. To get such a loan, the borrower can contact an insurance agent. The borrower must make sure that their cash value account has enough funds so that the borrower can be qualified for this type of loan. If the borrower's cash value account has reached a certain threshold, they can usually get a loan within about 10 days without a credit check and checking the borrower's income level.

What happens when you take a loan on your life insurance?

After the borrower has received a loan against their life insurance policy, they need to think over a loan repayment plan. Such a loan doesn't have a clear deadline before which the borrower must repay the entire loan amount. The borrower may not pay a penny for several years. If the borrower cannot repay the loan, the amount taken will be taken away from the "face value" or death benefit. If the accumulated interest plus the principal amount exceeds the borrower's face value, the borrower’s insurance lapses, and the entire loan amount turns into income, which is taxed.

Can a person borrow against life insurance?

Unlike people with term life insurance policies, people with permanent life insurance policies, such as whole life insurance or universal life insurance policy can borrow money against the cash value of their policy. Here, the cash value account acts as collateral, so such a loan is considered secured. A life insurance loan has all the advantages of a secured loan, such as a low-interest rate compared to other loans, a simple process of applying for and obtaining a loan, and a flexible repayment schedule.

Is it OK to borrow from life insurance policy?

Borrowing from a life insurance policy can be a viable option for individuals in need of immediate funds, but it requires careful consideration. One of the key advantages is the accessibility of funds without the need for credit checks or extensive loan application processes. Additionally, life insurance loans often offer lower interest rates compared to other credit products. However, it is important to recognize that borrowing from a life insurance policy reduces the death benefit that beneficiaries would receive. Furthermore, failure to repay the loan can result in policy lapses or termination, leading to potential financial losses. Therefore, individuals should weigh the immediate financial need against the long-term implications and ensure they have a sound plan for repayment before deciding to borrow from their life insurance policy. Seeking guidance from a financial advisor can provide valuable insights in making an informed decision tailored to one's unique circumstances.