How to Borrow Against Your Life Insurance

The image shows grandparents running on the beach.

How much cash is your policy worth?

If you need to get your hands on a lump sum of cash quickly, then you should consider taking out a loan from your permanent life insurance policy. This can often be the fastest way that you can take out a loan, as well as the cheapest. Cash value loans in permanent policies have been available to policyholders since the dawn of modern life insurance. And loans are available in many types of life insurance, such as whole life, universal life, variable universal life, and indexed universal life.

Accessing the cash value in your permanent life policy

There are several ways that you can get ahold of some or all of the cash value in your permanent life insurance policy. Perhaps the most straightforward method is to simply take out a cash withdrawal from your policy.

Though you can get your money relatively quickly this way, there will be fees and expenses to pay in addition to a back-end surrender charge penalty, depending upon how old your policy is. Most cash-value policies have back-end surrender charge schedules that can last for as long as 15 years.

Another alternative is to surrender your entire life insurance policy back to the life insurance company. You will receive the cash surrender value after all fees and expenses have been paid, provided there is enough cash value in the policy left over. But this option will also cancel the death benefit protection that you took out for your beneficiaries’ sake, so be sure to thoroughly discuss the matter with them and your loved ones before you do this.

Taking out a policy loan

Taking out a loan from your cash value policy may be the best way to get money fast if you are faced with a financial emergency of any kind. The actual loan disbursement process itself is very simple. It is broken down into the following steps:

  1. Check your policy to make sure that you have enough cash value built up in it to use as loan proceeds. You can do this online or by calling your life insurer.
  2. Notify your carrier that you would like to take out a loan. Tell them how much you want and also specify a method of payment (i.e. mailing a check, direct deposit, etc.).
  3. The life insurance company sends you, the borrower, the money using your preferred method and you can now spend it on whatever you need.
  4. The insurance company will charge you a relatively low rate of interest on the outstanding loan balance until it is repaid in full. But you may not have to repay the loan at all. If you die with an outstanding loan balance, then this amount will be deducted from your policy’s face value (death benefit). Just be sure not to take out so much that your policy lapses.

Keeping your life insurance benefits

Even if you do take out a loan from your policy’s cash value, chances are that you’ll still want your insurance coverage to remain in force. Therefore, it is crucial that you find out how much you can take out from your life insurance carrier so that your loan payout will not eventually make your insurance product lapse.

Three generations of men laughing on the couch, stress-free after having accessed quick cash by borrowing against life insurance.

For example, if you have $10,000 of cash value in your policy and you take out a loan for $5,000, then the interest that is charged on that amount may eventually exceed the amount of interest payments or dividends that you are earning in the policy. If this happens, your policy can lapse.

The advantages of life insurance policy loans

There are several advantages to using your cash value for a personal loan. Here are some of the biggest:

Low interest rates

Taking out a loan from your cash value life insurance policy is probably the cheapest kind of loan you can get from any lender under any circumstances. The rate of interest on your policy loan will almost assuredly be lower than what any bank loan or credit card would charge you. The finance charges that come with traditional loans can therefore be avoided.

Flexible repayment terms

As mentioned previously, some life insurance carriers don’t require the policy owner to repay their loans if they don’t want to or are unable to do so. And you don’t have to make payments every month even if you are repaying your loan. If money is tight in a given month, then you can skip your loan payment that month with no consequences (other than another month’s worth of accrued interest on the outstanding loan amount).

No underwriting

Unlike other types of consumer loans, there is no underwriting necessary to take out a policy loan. This is because you are essentially borrowing your own money, so there is no risk to the insurance company.

For example, if you have a policy with Northwestern Mutual, they will not run a credit check or background check on you, and you don’t have to worry about getting approved. Your credit score and any black marks on your credit report do not matter in this case.

Quick turnaround

If you take out a loan from your policy, you’ll probably get your money within 10 days or so, depending upon your preferred method of payment. Direct deposit will be faster than getting a check, so this is the preferred method of payment for the majority of policyholders today. You may also opt to receive a series of monthly payments instead.

The only real disadvantages to taking out a policy loan are the danger of causing your policy to lapse by taking out too much money, and the reduction of the policy’s death benefit if you die before repaying the loan. But both of these hazards can be avoided if the loan is eventually repaid.

What's your life insurance policy worth?

One other factor to consider is the additional premium payments that you will have to make for a period of time if loan repayment is your goal. But there is no set repayment schedule.

Whole life vs. term life insurance

In order for you to be able to take out a loan from your life insurance policy, it has to be some form of cash value life insurance, such as a whole life insurance policy, universal life, or variable universal life insurance.

You cannot take out a loan against a term life insurance policy because it does not accrue cash value of any kind. If you own a convertible term policy, then you can convert it to a smaller amount of paid-up permanent insurance and then borrow against the cash value.

The tax implications of borrowing against your life insurance

The IRS has mandated that there are no income tax consequences of any kind when you take out a loan from your life insurance policy. The money that you receive is considered to be a tax-free return of principal.

However, this is not the case if you make a direct withdrawal from your policy or surrender your policy in full. You will most likely have a tax bill if you use either of these methods to access your cash value. Keep in mind, the loan interest that you pay for your withdrawal is also nondeductible.

Get a free valuation of your life insurance policy

Taking out a loan against the accumulated cash value in your life insurance policy can be a practical solution when you need to come up with a lump sum of cash. Consult your financial advisor or life insurance agent for more information on policy loans and whether one is right for you. Your financial planner should be able to answer all of your questions quickly and easily. He or she can also get you a range of life insurance quotes if you are thinking of taking out a policy.

How much could you sell your life insurance for? Gen an instant valuation with our free life settlement calculator.

Author:
Chris Granwehr is the Founder of Dawn Life Settlements and a former senior manager with Mason Finance, an industry-leading life settlement provider in California. He's a member of the Life Insurance Settlement Association, and he has a passion for empowering customers financially through a faster, easier life settlement system.