Borrowing against life insurance: What to know
Learn about the ins and outs of borrowing against a life insurance policy, how it works and factors that might influence whether it’s the right choice for you.
Life is unpredictable — that’s one reason why we have life insurance policies in the first place. Borrowing from life insurance can get cash in hand quickly if the need arises, but as just one option among many, it requires extensive consideration. Only you can determine the best choice for your situation, including whether or not to borrow against life insurance.
How do life insurance loans work?
Certain types of insurance have a financial value inherent to their structure, known as a cash value. The way an insurance loan works is the owner of an insurance policy requests a loan from their insurer, using the cash value of the life insurance policy as collateral for the loan.
Eligible policy types
Only policies that have cash value are eligible for use in life insurance loans. These policies are commonly referred to as permanent polices, which mean they are designed to provide life-long protection. The two primary forms of permanent life insurance are ‘Universal’ and ‘Whole’. Each offers distinct characteristics worth considering in the search for your preferred insurance policy.
Universal Life insurance
Universal Life insurance policies offer flexibility in both premiums and the face amount of coverage within specified limits. It provides more flexibility than Whole Life to help address your changing needs.
Whole Life insurance
Whole Life insurance provides the policyholder a guaranteed death benefit and guaranteed premium for their entire life. Whole life policies have premiums that can be paid in a lump sum, over a set period of years or over the insureds lifetime.
How much can I borrow from my life insurance policy?
Over time, permanent life insurance builds cash value that can be borrowed against. The growth of cash value can vary for many reasons. This will depend on the structure of your specific policy, but this can often take a few years at minimum from the start of policy activation.
Pros and cons of life insurance policy loans
Pros:
Favorable terms: Insurance policy loans tend to offer lower interest rates than a personal loan or credit card. Lower interest can mean reduced cost overall and faster repayment of the principal (the original amount loaned).
Tax-free: Typically, loans are Federal income tax-free. If you have any questions regarding policy loans a qualified tax professional can assist you.
Greater accessibility: Insurance policy loans don’t require credit, income or employment checks.
Cons:
Valuation: Until your loan is fully repaid, the cash value of your policy is reduced by the remaining debt. If the policyholder passes before the loan is repaid, any outstanding debt will be taken out of the death benefit before the beneficiary receives the remainder.
Required maintenance: If payments are not made to at least cover the loan’s interest, the amount owed can grow beyond the total cash value of the policy itself.
Paying back an insurance loan
As a secured loan, life insurance loans usually don’t have ironclad rules on when and how you must make payments. That said, you don’t want to let it slide — insurance loans lose some of their unique advantages if the amount owed is allowed to grow unchecked. If the balance of your debt exceeds the cash value of your policy, not only could you be subject to income taxes on the loan, but your policy can be considered lapsed, as the death benefit can no longer cover the entirety of the amount owed.
On the flip side, if you stay proactive in paying off the interest and paying down the principal, you can not only repay the outstanding debt but also regain the full value of your policy, providing the stability that a life insurance policy should.
Considering a life insurance loan? You don’t have to do it alone. Talk to a State Farm® agent to get more personalized information and answers to your questions today.
