Life Insurance

Borrowing Against Your Life Insurance: When Should You Take out a Policy Loan?

Borrowing Against Your Life Insurance: When Should You Take out a Policy Loan?

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It’s simple to borrow against the cash value of a permanent life insurance policy as there are no loan requirements or qualifications aside from the amount of cash value you have available. A life insurance policy loan can be used for any purpose and paid back whenever you decide. In addition, life insurance collateral loans typically have quite low interest rates. However, if you’re unable to pay the policy loan’s annual interest and the policy lapses, you run the risk of losing coverage and having a large tax payment.

Can You Borrow Against Your Life Insurance Policy?

Each time you pay premiums for a cash value life insurance policy, such as a whole or universal life insurance policy, part of the premium is put towards the cash value. The cash value grows over time at an interest rate set by the terms of the policy, and is equivalent to the amount of money you would receive if you surrendered the policy to the insurer.

If you have a permanent life insurance policy that accumulates cash value, you can borrow money from the insurer using the cash value as collateral. However, this option is typically only available once your life insurance policy’s cash value has reached a certain size, which may take five to ten years of paying premiums.

Term life insurance policies are cheaper that permanent policies in large part because they don’t have a cash value component, so you’re not able to borrow against them. In addition, if you decide to surrender a term life insurance policy, you wouldn’t receive money in return.

How Much Can You Borrow from a Life Insurance Policy?

How much you can borrow from a life insurance policy varies by insurer, but the maximum policy loan amount is typically at least 90% of the cash value. There usually is not a minimum amount you can borrow.

When you take out a policy loan, you’re not actually removing money from the cash value of your account. Instead, you’re taking a loan from the insurer and just using the cash value as collateral. This is actually a significant benefit as it means the cash value being used as collateral stays inside your life insurance policy and continues to accumulate interest, though it may be at a different rate.

In addition, since the cash value is being used as collateral you don’t need to pay back the loan in a set period of time, as is required of many other forms of loan. However, if you don’t pay the insurer the annual interest, which can be fixed or variable, the interest payment will be added to the value of your outstanding loan. This has the downside of compounding interest if the policy loan lasts multiple years. Plus, if the total outstanding loan reaches the size of your policy’s cash value, the policy will lapse.

When a policy lapses, you not only lose your coverage but also will have to pay income taxes if the outstanding loan is greater than the amount you’ve paid in premiums. Therefore, while you may be able to borrow nearly the entire amount of the policy’s cash value, this can be incredibly risky. If you take out a policy loan, you should always carefully monitor its size as compared to your cash value and we would recommend making interest payments whenever possible.

How Do You Take Out a Life Insurance Policy Loan?

The process of taking out a life insurance loan is incredibly simple. You just fill out a form from the insurer and will often get the money deposited in your account within a few days.

You may need to confirm you identity, sign a confirmation document or provide a notarized confirmation before receiving your loan if:

  • You provided new account information to the insurer in the last month
  • The policy changed ownership recently
  • The loan exceeds a certain size, such as $50,000

Pros and Cons of Taking Out a Life Insurance Collateral Loan

Life insurance collateral loans are a simple way to get money on short notice with few restrictions. You need to be very careful with regards to managing the cash value in the account and paying off interest as needed. However, besides the risk of the policy lapsing, there are few downsides to borrowing against your universal or whole life insurance policy.

There are No Qualifiers for a Policy Loan

Unlike other loans, you don’t need to qualify to borrow against your life insurance policy. There’s no credit check, so the loan doesn’t appear on your credit report. And you don’t have to provide proof of income. At most, you’ll just have to prove your identity and that you’re actually requesting the loan.

Since there are no checks or qualifications, life insurance collateral loans can be a great solution if you need money quickly, such as for an emergency medical expense. Alternatively, they can be used as a stop-gap if you’re applying for a loan elsewhere that is taking a long time to be approved.

Policy Loans Have Low Interest Rates

Life insurance collateral loans typically have lower interest rates than you would get with a personal loan or credit card. While rates vary by insurer and policy, they typically fall within the range of 6% to 8%. To illustrate, we collected loan interest rates for variable universal life insurance policies from three of the largest insurers:

InsurerProductPolicy Loan Annual Interest Rate
Northwestern MutualCustom Variable Universal Life Insurance5%, plus up to 2% additional debt expense charge
New York LifeVariable Universal Life Accumulator6% maximum, currently 3%
PrudentialVariable Universal Life Protector2% if policy has been in place less than 10 years, else 1.05%

In addition, your cash value continues to earn interest during the loan. This may either be at a fixed rate (such as 1.5%) or within a certain spread of the loan interest rate. For example, if your cash value was guaranteed to grow at a rate that was within 2% of your loan interest rate, which was 6%, it would be guaranteed to be at least 4%.

You Can Pay Back a Life Insurance Policy Loan at Any Time

When you borrow from your life insurance policy, you don’t actually have to pay back the loan. In addition, you don’t have to pay the annual interest so long as the total outstanding loan (original loan plus accumulated interest) doesn’t exceed the policy’s cash value. Therefore, borrowing from your life insurance policy is a great alternative if you aren’t sure how long you’ll need the loan.

Now, it’s typically to your benefit to pay back a policy loan in a timely manner as the interest compounds annually and the policy will lapse if the outstanding loan gets too large. This could mean you not only paid thousands of dollars in premiums and would have no coverage, but you could also pay taxes if the outstanding loan is greater than what you’ve paid in premiums.

Another reason to pay back the policy loan is that the total outstanding balance would be deducted from the death benefit your beneficiaries received if you passed away.

Maxime Croll

Maxime is a Director at ValuePenguin focusing on the insurance industry. Previously she was the Director of Product Marketing at CoverWallet, a commercial insurance startup, and helped launch NerdWallet's personal insurance business. Maxime has contributed insurance insights and analysis to Forbes, USA Today, The Hill, and many other publications.

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.