With a huge number of ways to borrow money both online and off, it can be difficult to decide which is the best route. One option is borrowing money from a life insurance policy.
Of course, those without a life insurance plan will have to invest in one before they can consider borrowing from it. But even those with an existing policy may not know all the important ins and outs of taking advantage of this method.
Read on for all the ins and outs of borrowing from life insurance.
How Borrowing from Life Insurance Works
The first thing everyone should know about borrowing money from a life insurance policy: it’s only possible if you have a whole life or universal life policy.
Term life insurance policies don’t offer this feature, which is part of the reason why they’re usually more affordable than a whole life policy. If you have a whole life policy, your insurance representative probably made you aware of this feature when you first signed up for the plan. Even if you’re sure that your plan allows you to borrow money, it’s usually best to contact your insurance rep to talk about how getting a loan will impact your policy.
It’s also important to understand that life insurance loans are only available after you’ve been paying premiums for a significant period. You can’t get an insurance policy and then immediately borrow against it. First, you must build up cash value on your policy. After a few years, insurance companies will allow policyholders to borrow against the cash value, although some insurers will have a cap of around 90% on how much you’ll be able to borrow.
Essentially, you are using your policy as collateral to borrow money. So, the longer you have the policy, the more you can borrow against it.
The Pros and Cons of Borrowing Money from Life Insurance
While borrowing from a life insurance policy can be a legitimate and useful way to get a loan, there are plenty of pros and cons to weigh before jumping into anything. In addition to asking your insurance rep about what borrowing money will mean for your policy, it’s important to compare the positives and negatives in regards to your specific situation.
Pro: A Life Insurance Loan Can Be Fast and Large
The most significant advantage of borrowing against a life insurance policy is that you have money available to you when you need it. Obviously, getting a loan from your life insurance isn’t something to do lightly and shouldn’t become a habit. However, if you don’t have enough in your savings or an emergency fund to cover an unexpected expense, it’s a nice fallback option.
In a lot of ways, getting money from your life insurance is easier than getting a loan from a bank or credit union. For starters, there is no lengthy application and no long wait while the bank decides whether or not to give you a personal loan.
On a related note, life insurance companies don’t ask a lot of questions about why you need the money the way other financial institutions might. You can use the money you get from your life insurance policy for whatever you want, no explanation required.
Pro: No Credit Check
Life insurance loans don’t have a credit check like traditional bank loans. Life insurance companies won’t perform a credit check because the loan is based on the cash value you’ve built up for your policy.
Firstly, a credit check can hurt your credit score, so that’s avoided. Second, you don’t have to worry about a loan from a life insurance company showing up on your credit report the way a traditional bank loan would. This makes borrowing from your life insurance a good option if you have less than perfect credit.
Pro: APR and Payment Schedule Can Be Better Than a Traditional Bank Loan
Paying back a loan you borrow against your life insurance policy is easier than it would if you got a personal loan from a bank or borrowed money against your credit card. Life insurance loans rarely have monthly payments you have to make, allowing you to pay it back on your own schedule. They also come with lower interest rates than most personal loans or credit cards because of the cash value you’ve built in the policy.
Con: A Loan Requires a (Relatively) Robust Policy
As mentioned, one of the downsides of borrowing money from an insurance policy is that it takes time to build up cash value on the policy. If it’s a relatively new loan, you won’t be able to borrow as much from the policy. In fact, you may not be able to borrow from it at all until you’ve paid premiums for several years.
Con: Reduced Life Insurance Benefits
Even if you’re able to borrow money from your life insurance, doing so will reduce your policy benefits until the loan is paid back. Odds are, you have a life insurance policy in the first place for the sake of your family if you pass away. However, the policy won’t pay out as much if the loan isn’t repaid in full. It’s important not to lose sight of this when you consider borrowing against your policy.
Con: You Could Lose Your Life Insurance Policy for Lack of Payments
On a similar note, you also run the risk of losing the policy altogether if you don’t have a plan in place to repay the money you borrowed. If the unpaid loan plus the interest total more than the policy is worth, your insurer can cancel your coverage, leaving you without a life insurance plan altogether.
Further, not making premium payments on time can also result in your policy lapsing. This is why not having monthly payments with this kind of loan can be a double-edged sword; it’s up to you to make sure you’re paying back the money you borrowed.
Con: Tax Concerns
Potential tax consequences can arise when you borrow against a life insurance plan. The specifics can get a little complicated (as is the case with taxes in general). But if your policy lapses or gets canceled, you can end up owing taxes on the money from the policy. This is another potential complication of borrowing from a life insurance plan if you’re not going to be able to pay back the funds in a reasonable amount of time.
For more personalized service, we recommend reaching out to a financial advisor, who can go over your finances and options to offer expert advice. Treat this as a general guide, and remember: you can never overthink or over-research a new loan, whether from a life insurance policy or otherwise.