How Can I Borrow Money From My Life Insurance Policy? (2024)

Whileborrowing from your life insurance policycan be a quick and easy way to get cash in hand when you need it, there are a few specifics to know before borrowing. Most importantly, you can only borrow against a permanent life insurance policy, meaning either a whole life insurance or universal life insurance policy.

Term life insurance, a cheaper and more suitable option for many people, does not have a cash value. It is designed to last for a limited period of time, which is generally anywhere from one to 30 years. However, in some instances, a term life policy can be converted to a permanent policy in which cash value can build.

Policies You Can Borrow From

Both whole life and universal life insurance policies are more expensive than term, but have no pre-determined expiration date. If sufficient premiums are paid, the policy is in force for the lifetime of the insured. While the monthly premiums are higher than term, money paid into the policy that exceeds the cost of insurance builds in a cash value account that's part of the policy. The purpose of the cash value is to offset the rising cost of insurance as you age. This is so premiums can remain level throughout life and not rise to unaffordable amounts in your later years.

Permanent life insurance has a few important values: the face value, the death benefit (often the same as the face value), and the cash value. One common misconception is that the cash value increases the death benefit. This is only true on certain types of permanent policies; on most policies it does not increase the death benefit.

Money in the cash value grows at a rate that depends on the type of policy. For example, in a regular universal life policy, it grows based on current interest rates, while in a variable universal life policy, the cash value is invested by the owner in the stock market (and grows accordingly). It usually takes at least a few years for the cash value to build to sufficient levels to take out a loan.

How a Life Insurance Loan Works

Unlike a bank loan or credit card, policy loans do not affect your credit, and there is no approval process or credit check since you are essentially borrowing from yourself. When borrowing on your policy, no explanation is required about how you plan to use the money, so it can be used for anything from bills to vacation expenses to a financial emergency.

The loan is also not recognized by the IRS as income, therefore it remains free from tax as long as the policy stays active (provided it's not a modified endowment contract).It's still expected that a policy loan will be paid back with interest (though the interest rates are typically much lower than on a bank loan or credit card) and there is no mandatory monthly payment.

Paying Back the Loan

Even with low interest rates and a flexible payback schedule, it's important that you pay the loan back in a timely manner—on top of your regular premium payments. If unpaid, interest is added to the balance and accrues, putting your loan at risk of exceeding the policy's cash value and causing your policy to lapse. If that happens, it's likely you'll owe taxes on the amount you borrowed.

Insurance companies generally provide many opportunities to keep the loan current and prevent lapsing. If the loan is not paid back before the insured person's death, the loan amount plus any interest owed is subtracted from the amount the beneficiaries are set to receive from the death benefit.

The Bottom Line

Permanent life insurance that accumulates a cash value can provide certain living benefits, in addition to its death benefit. Among these include the ability to borrow against the cash value of the policy and to make cash value withdrawals. When you take a loan against your policy, your insurer lends you the money and uses the cash in your policy as collateral—you do not actually withdraw any money from the policy itself. This means that the policy's cash value can continue to accumulate—but it's important to check with your insurance company how interest and any dividends will be determined and paid when you have an active loan.

Policy loans can be useful financial tools, but they can also create financial turmoil. If you don't make interest payments, your policy could lapse and the entire loan amount could become taxable. And if you pass away, the loan amount and any interest owed will be taken out of the death benefit, which could significantly impact your beneficiaries. Be sure to thoroughly consider the pros and cons of life insurance policy loans in the context of your situation before taking one out.