Many people choose life insurance to provide money for the use of their families when there is an income loss after death. There are life insurance companies that offer the ability to take a loan against the insurance policy. Borrowing against your life insurance policy has various advantages, but this must still be considered a loan.
You are able to withdraw or borrow money from your life insurance plan. Other than that, you can still be fit and healthy and get a lot of benefits from your insurance policy. The process of borrowing against your cash value is quite simple, as there are no qualifications or loan requirements aside from the cash value amount that you have already available.
You have the benefit of borrowing this money for any purpose and pay it back whenever you decide. In addition to that, the collateral loans of life insurance normally have quite low-interest rates. But if you are unable to pay the annual interest of the policy loan, then you may lose coverage.
Can one borrow against a life insurance policy?
Every time you pay your premiums to build the cash value of your life insurance policy like universal or whole life insurance, some part of the premium goes towards the cash value. Over a period of time, the cash value grows at an interest rate that is set by the policy terms, and it is equivalent to the amount of cash that you will be able to receive if you surrender your policy to the insurance company.
In case of a permanent life insurance policy in which the cash value is accumulated, you can borrow money from the insurance company by using your cash value as collateral. You should keep in mind that this option is only available once the cash value of your life insurance policy reaches a certain size, and this could take as much as ten years of paying the premiums.
As far as the term life insurance policies are concerned, these are cheaper as compared to the permanent life insurance policies as they don’t have a cash value component; therefore, you are not able to borrow against these. In addition to that, if you happen to decide to surrender your term life insurance policy, then you will not receive any money in return.
What is permanent or cash value insurance?
The cash value insurance policy is always permanent, and this means that it will not expire. Your beneficiaries will be able to receive the death benefit, and it does not matter when you pass away. As long as you pay your premiums regularly, your cash value or permanent life insurance policy should not lapse.
The longer you are able to pay for your life insurance plan, the more cash value builds up. This cash is a part of the premium payments that you are able to pay on a monthly, quarterly, or yearly basis. Over a period of time, you will have enough cash that you can borrow or withdraw from. Though it depends on your insurance company, you might be able to take out a loan against your permanent insurance policy after about ten years or so. Your insurer will be using this cash value as collateral for a loan.
The accumulated cash value of your policy can also be used to pay your premiums or any other purpose. You are able to use this coverage to get a higher death benefit. All of these extra features are the main reasons why whole life insurance policies cost more as compared to the term life policies.
On the other hand, the term life insurance has an expiry date, and it can be 10 to 20 years or longer. In addition to that, no matter how long your term insurance policy is, this policy will never be able to accumulate cash. But, your life insurance provider may allow you to convert your term insurance policy to a permanent one.
If you don’t have any life insurance yet, then it is always better to consider whole life insurance instead of the term policy. In this way, you should be assured that you receive the coverage for life, whereas permanent life insurance also offers you additional sources of money.
How much can you borrow from your life insurance policy?
The amount that you are able to borrow from your life insurance policy varies by the life insurance provider, but the maximum policy loan is normally around 90% of the cash value. Normally there is not a minimum amount that you can borrow.
When you are to take out a policy loan, you are not removing this money from the cash value policy account, but instead, it is considered as a loan from the insurer, and using the cash value is only collateral. This can be quite useful for you as it means that the cash value that is being used as collateral stays inside the life insurance policy and also continues to accumulate interest, though the interest rate can be different.
In addition to that, as the cash value is being used as collateral, therefore, you don’t have to pay back your loan in a set period of time, as is the requirement of other types of loans. However, if you fail to pay the annual interest to the insurance company that is fixed or variable, then this interest payment will be added to your outstanding loan value.
If your policy loan lasts for many years, then it has the downside of your compounding interest, and the policy might lapse if your total outstanding loan equals the size of the cash value of your insurance policy.
When your policy lapses, not only that, you lose the coverage, but you will also be required to pay the income taxes if the outstanding loan exceeds the amount of the premiums that you have paid. Therefore, you might be able to borrow almost the entire amount of your policy cash value, but this can be very risky for you. While taking a policy loan, it is always better to carefully monitor the size of the loan as compared to the cash value, and it is recommended to make the interest payments when possible.
There is no doubt that life insurance loans are useful when you need your hands on some quick cash, as getting approval from a bank or other lender may be difficult and slow. There are no underwriting requirements for life insurance loans and require a little to no paperwork to fill out. The main reason is that you are to borrow against your own money instead of using somebody else’s money.
Before you take a loan against the cash value of your life insurance policy, you should consider the following factors.
- Try to take as much information as possible regarding how the loan balance will be affecting your death benefit.
- Also, try to look at whether there is an opportunity cost to taking out a loan.
- You know your financial condition more than anybody else, so make sure that you are able to afford to make any extra payments in order to repay the loan.
- You have to think twice before taking out the loan, especially if you are aware that you will not be able to repay it. A good illustration of your policy can help you to see how this can impact you.
- You should meet your financial advisor or life insurance agent to go over your insurance policy if you intend to use the interest or dividends that are paid into your policy so that interest is paid on your loan.
The advantages of taking out a life insurance loan
Life is unpredictable, and sometimes we encounter a financial emergency, and we require cash in these unexpected events. If you happen to find yourself in such a situation, then you may not be able to withdraw much from the cash value policy. In order to take a policy loan, you should have enough cash value. One of the biggest advantages of policy loans is the availability of cash when you require it. The following are the other advantages of buying against your policy rather than buying from another lender.
- No qualifiers for a policy loan
Unlike other loan types, you are not required to qualify in order to borrow against your life insurance policy. There is no such credit check; therefore, the loan does not appear on the credit report. You don’t need to provide any proof of your income, but it is a simple process in which you have to prove your identity to show that you are actually requesting the loan.
As there are no qualifications or checks in taking out a policy loan, these life insurance collateral loans are no doubt a great solution if you quickly need cash e.g., for any emergency medical expense. Alternatively, this borrowing can also be used as a stop-gap if you are applying for a loan anywhere else, and it is taking a little longer to get approved.
- Guaranteed approval
It is very easy to take out your insurance policy loan as compared to the traditional personal loan that you take from a bank because you already have collateral. Your insurance company will be using the accumulated cash value of the policy as a security for the loan. Therefore, if you have built enough cash value, you can easily take out the policy loan without being questioned.
In the case of personal loans, you don’t require any collateral and security. This is one of the main reasons why personal loans are not easy to qualify for. A study shows that as many as three-quarters of the applications of personal loans get rejected.
- Policy loans have low-interest rates
Normally there are lower interest rates for the life insurance collateral loans as compared to the personal loan or the credit card. While the interest rates depend on the insurance provider and the policy, these normally fall within the average of 6% to 8%.
There is another advantage that, even during the loan, your cash value continues to earn interest. This could either be a fixed interest rate or an interest rate within a certain spread of a loan.
- The loan can be paid back any time
When you take a loan from your insurance policy, you basically don’t have to pay back this loan. In addition to that, there is no requirement to pay the annual interest as long as your total outstanding loan does not exceed the cash value of your insurance policy. Therefore, borrowing from the life insurance policy is no doubt a great alternative, especially if you are not sure about how long you will require the loan.
It will be beneficial for you to pay back your policy loan in a timely way as the interest compounds manually, and your policy might lapse if your outstanding loan gets too large. This means that not only have you paid thousands of dollars in premiums, and would be having no coverage, but you also might have to pay taxes if the outstanding loan exceeds your premium payments.
- No credit check required
It is your money; therefore, the insurer will not pull out your credit report. Also, your policy loan will not be appearing on your credit report. Traditional loans and credit cards need hard credit checks, and you must be aware that these hard checks can have quite a negative impact on your credit score. Once issued, these loans and credit cards will always show up on your credit report.
Borrowing against your life insurance policy is a good low-cost alternative to your personal loan. Keep in mind that if you have decided to take out a policy loan, then you have to make sure that you pay it back, though the time to return this loan is flexible and up to you. Stick to your plan to repay the loan in full if you want your family to make use of the death benefit.
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