Key points
- It’s possible to borrow against whole, universal or variable permanent life insurance.
- Life insurance loans typically have lenient application requirements and relatively low interest rates.
- However, failing to replenish your policy’s cash value could mean lapsed life insurance coverage and a big income tax bill.
Permanent life insurance is an attractive option for many consumers. Not only does it provide coverage for your entire life, but it also builds a cash value that you can use later in life. You can also take out a loan against your life insurance policy.
A life insurance loan can help you get cash when you need it, acting as an emergency fund you hope you’ll never have to use. Borrowing from your life insurance policy is often easier and more affordable than a traditional bank loan, but it’s not without risk.
Understanding your options as well as the benefits and drawbacks of a life insurance loan can help you decide if this type of financing is right for you.
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Types of life insurance you can borrow against
There are two primary types of life insurance: term life insurance and permanent life insurance.
Term life insurance offers a level premium and guaranteed death benefit for a specific period of time, or term, such as 10 or 20 years. It doesn’t include a cash component and you cannot borrow against it.
If you have permanent life insurance, you have the death benefit as well as a cash value. The cash value builds with interest over time. When you borrow against a permanent life insurance policy, your cash value serves as collateral for the loan.
Types of permanent life insurance policies that you can borrow from include:
- Whole life insurance.
- Universal life insurance.
- Variable life insurance.
How a life insurance loan works
The process of borrowing from your life insurance policy is fairly easy. In most cases, you can simply call up your insurance company and request the loan. In other cases, you may be able to complete the entire process online.
“There are no lending requirements and no restrictions on the use of funds,” says John Graves, founder and managing partner of G&H Financial Group.
You’ll also often have access to better interest rates on a life insurance policy than you would on a bank loan. And loan eligibility is based on your life insurance cash value rather than your creditworthiness, meaning the money is more accessible, particularly if you have a spotty credit history.
When you borrow against your policy, you can typically pay yourself interest on the loan, but your insurer may charge a fee, known as a spread. How much you’ll have to pay to borrow money depends on your insurer. It’s generally between 0.25% and 2%, though a spread can be as low as 0%.
When you take out a life insurance loan, you can usually extend repayment as long as you like, but that doesn’t mean you should.
The best course of action is to make regular cash payments until you’ve repaid the loan, plus interest, in full. If you don’t repay your loan before you die, your death benefit will be used to cover the outstanding balance.
Life insurance loans pros and cons
Life insurance loans are an attractive option that can help you access funds without needing to apply for a traditional loan. But there are pros and cons to borrowing money from your life insurance.
Suppose you have a universal life insurance policy and have built up a cash value of $50,000. When you need funds to cover some unplanned home repair expenses, borrowing against your life insurance policy may seem like a good idea since there are few requirements, no credit check and low interest rates.
Your insurance company allows you to borrow up to 90% of your cash value amount. In this scenario, that means you can take a life insurance loan of $45,000.
Unlike other loans, life insurance loans don’t have a set repayment schedule. As a result, you can pay it back on a schedule that works for you, though extending repayment for too long can have significant downsides.
While the rates on life insurance loans are often more competitive than personal loans, they do accrue interest. And if the interest accrues at a faster rate than you repay the loan, your policy could lapse. Not only would this result in you not having coverage, but there could also be tax implications.
Even if your policy remains in force, there could be less money available for your family if you pass away before paying back the loan. The amount you owe will be deducted from your death benefit, leaving your beneficiaries with a smaller payout.
| PROS | CONS |
|---|---|
Easier to qualify for than other loan types | Failure to repay before death will reduce or eliminate death benefit |
Lower rates when compared to other financing options | Accumulating interest can lead to policy lapse and tax implications |
Credit check not required | Must meet policy’s minimum cash value requirement |
Restrictions of a life insurance loan
It’s also worth noting that, even with fewer borrowing requirements, there are still some restrictions on life insurance loans.
You generally must have a minimum amount of cash value built up, for instance, meaning you won’t be able to borrow early on. You’re also usually limited to a certain percentage — often 90% to 95% — of your cash value balance. Depending on your cash value, a life insurance loan may not be enough to cover your needs.
Life insurance loans FAQs
The amount you can borrow from your life insurance policy depends on the amount of cash value you’ve built up and your policy terms. Insurers generally allow you to borrow up to 90% of 95% of your cash value amount.
You do not need to repay your life insurance loan, but there are risks associated with failing to do so. If you don’t repay the loan before you die, the remaining balance will be deducted from the death benefit. That means your beneficiaries won’t receive the funds you intended or they may need.
In addition, even though life insurance loans have low interest rates, interest does still accrue. If too much interest accrues, your policy will lapse and you will on longer have coverage.
As long as you repay the loan, there are no tax implications. But if you fail to repay the loan and your policy lapses, the IRS considers the loan income and you’ll need to pay taxes on it.
