There are a few things you should be aware of before taking out a loan against your life insurance policy, even though it might be a quick and straightforward way to receive cash when needed. Most significantly, only permanent life insurance policies—whole-life or universal life insurance policies—may be used as collateral for loans. So read along as we discuss how to borrow against your life insurance policy.
How to Borrow Against Your Life Insurance Policy
Following this procedure is the correct action if you have decided to contemplate at least borrowing against your life insurance policy.
#1. Speak with Your Life Insurance Provider About Your Eligibility for a Loan
Ensure your current life insurance policy qualifies as collateral for a loan from your provider before proceeding. The regulations governing this can change, but generally speaking, it comes down to ensuring that you have accumulated enough financial value for a loan to be approved.
Making immediate contact with your life insurance provider is the recommended course of action. To determine if your policy qualifies for loans or if you still need to achieve cash value or policy timeline milestones, speak with a representative.
#2. Ascertain Your Borrowing Capacity
In addition to determining your eligibility for a life insurance loan, find out how much you could currently borrow when you contact your provider. You can borrow up to 90% of the cash value of your life insurance policy, according to several insurers. Under such a policy, you could take out a loan for up to $9,000 if you have $10,000 in cash.
#3. Examine the Pros and Cons of Taking Out Life Insurance
It’s time to determine how much you should withdraw from the policy now that you know the maximum amount you can borrow against your life insurance payout. Consider these life insurance loan benefits and drawbacks to help you decide.
#4. Examine Loan Conditions and Interest Rates
Ensure the terms and interest rate of the life insurance loan are acceptable before proceeding with the application. In summary, go over the contract terms and make sure you read the fine print to understand the conditions and duties related to the loan. See a financial counsellor if you need assistance making a decision or if you have questions about any of the loan terms.
#5. Finish the Application for a Policy Loan
Filling out an application for a policy loan comes next. Just telling your provider the life insurance policy you want to use as collateral for the loan and giving them details about where you want the money deposited could suffice to accomplish this.
#6. Await Financing After Receiving Approval
You now have to wait for the funds to be deposited into your account and for the approval process to be completed. The timeline for this can vary by provider. However, be ready to wait for the approval and the completion of the cash payout could take up to one month.
#7. Pay Back Loans on Schedule
After you receive your money, plan out how and when you will pay back the loan. Avoiding the risks associated with life insurance policy loans can be accomplished by creating a repayment plan that you can follow. Suppose you can only begin making interest payments. In that case, it is still preferable to delay repayment indefinitely and let interest accrue, which could jeopardise your benefits if the interest balance rises too high.
Borrow Against Your Life Insurance: How It Works
Since you are essentially borrowing from yourself, policy loans have no approval process or credit check, unlike bank or credit card loans, which impact your credit. You can use the money you borrow against your policy for anything from bills to emergency savings to travel expenses—you are not required to explain how you intend to use it.
As long as the policy is in effect, the loan is likewise not taxable because the IRS does not consider it income. However, it is still expected to be repaid with interest (although the interest rates are usually much lower than on a bank loan or credit card).
Repaying the Debt
You must make timely loan repayments in addition to your monthly premium payments, even with low interest rates and a flexible payback timeline. The risk of your loan exceeding the cash value of your policy and your coverage lapses arise from interest being added to the balance and accruing if it is not paid. You’ll have to pay taxes on the amount you borrowed if that occurs.
Insurance providers typically offer numerous chances to maintain the loan and prevent it from expiring. The loan amount plus any interest due is deducted from the amount the beneficiaries are expected to receive from the death benefit if the loan is not repaid before the covered individual passes away.
Different Ways Life Insurance Works
#1. Direct Loans
By using the cash value of the policy as collateral, you are effectively borrowing money from yourself when you take out a direct loan. You are, therefore, exempt from paying income tax on the money you withdraw. Additionally, the insurance provider will impose interest (also known as a spread).
You reimburse yourself for the interest minus an insurance company spread. This can often range from 2% to as little as 0.25% (or even 0% in certain circumstances).
Picking a policy with a low loan spread can make a big difference. “In any case, policy loans diminish the value of the policy account and the death benefit by the loan amount on a dollar-for-dollar basis.”
The insurance loan is not deducted from your death benefit if you pay it off before you pass away.
#2. Automatic Premiums Loans
If you cannot pay your life insurance premiums, the insurer may utilise your cash value through an automated premium loan (APL).
Consumers are frequently unaware of the ramifications of automated premium loans, even though insurers usually notify them of them. Thus, a policy loan may accrue over many years.
Interest is also applied to the balance—often at negative interest rates. Thus, if policyholders are unaware of these consequences, they may allow APLs to get out of control, which could lead to a policy lapse from declining cash value.
Things to Consider Before Borrowing Against Your Life Insurance Policy
Make sure you comprehend the terms of your policy and all of your alternatives before applying for a policy loan. Carefully reading your policy documentation should allow you to confirm some details. You can always get in touch with your insurance agent, though, if you have any questions or want to be sure.
The following is a detailed list of actions to take before using your policy for borrowing:
#1. Check the Sort of Policy You Have
Term policies typically lack a cash value component, whereas permanent policies typically do. You cannot borrow against a term policy if you have one. If you wish to take advantage of this option in the future, you might want to think about converting your policy to whole-life insurance.
#2. Check the Amount in Cash Right Now
Find out the current value of your policy. By visiting the website or mobile app of your life insurance provider, you ought to be able to do this research on your own. You can obtain documentation by giving the company or your agent a call directly if you are unable to locate it.
#3. Talk About the Terms
Discuss policy loans with your representative regarding how your insurer handles them. Find out the maximum amount you can borrow and the minimum cash value that is needed. Additionally, you can inquire about any repayment conditions and interest rates.
#4. Consider the Options
There are other ways to obtain the cash value of your insurance besides policy loans. For example, you could be allowed to take money out. This method does not require interest payments, but it will probably diminish your death benefit. Additionally, you can pay your coverage premiums in cash. Inquire with your representative about your policy’s cash surrender value if you don’t need life insurance.
How Do You Repay a Loan for Life Insurance?
Loans secured by life insurance policies are not subject to a set payback period, unlike other forms of loans. You are free to take your time. However, because interest accrues, holding the money indefinitely may have unfavourable effects. That’s why it makes sense to repay a loan you take out against your insurance as soon as possible.
Policy loans include three options for repayment.
Ideally, you would pay the life insurance provider back in cash to repay your loan. On a dollar-for-dollar basis, repaying in cash increases the value of the policy account and the death benefit.
#2. Policy Worth
According to Flagg, a policy loan can be repaid with “excess” cash value if the costs associated with the policy can be decreased and the cash value is more than adequate to meet the reduced costs. However, he cautions that repaying the loan in this manner may result in a taxable event if the repayment amount exceeds the policy cost or tax basis.
#3. Death Benefit
The loan balance from your insurance will be subtracted from your death benefit if it is still unpaid at the time of death. A less benefit will be given to your recipients. Nevertheless, Flagg claims that this method of repaying policy loans is the most tax-efficient one (as opposed to repaying with cash already taxed or a withdrawal of excess cash value that may be taxed), as death benefits are paid tax-free.
Advantages of Borrowing Against Your Life Insurance Policy
The fact that borrowing from your policy is reasonably easy is one of its main benefits. Compared to other loan kinds, policy loans have less impact on credit and taxes. Policy loans are an entirely tax-free funding source because the IRS does not count them as income. You won’t be subject to a rigid payback plan and can use the money however you see fit. Your credit score is unaffected by the loan, and the interest rate of the loan is unaffected by your credit score.
A policy loan can be obtained without a credit check or job verification. You are not required to pledge other assets as collateral or reach a specific income criterion. There is just a minimal financial value needed. You can get a cheaper rate than you would with a credit card or bank loan, and the money can be sent into your account in a few days because the lender bears almost no risk.
Disadvantages of Borrowing Against Your Life Insurance Policy
There are certain drawbacks to using policy loans, the first of which is how they affect the face value of your permanent life insurance policy. Your coverage amount decreases over the repayment period. Your loved ones won’t receive the entire death benefit of your insurance if you pass away before paying back the debt.
There can be further repercussions if the loan is not returned. Interest will be applied to the total amount of your loan as it accrues. Eventually, if the unpaid debt surpasses the policy’s cash value, your insurance may lapse, and you will no longer be covered.
You might have to pay income tax on the amount borrowed if your coverage terminates during the payback period. At the very least, consider paying interest on time to prevent this. Additionally, take care to make your premium payments on time.
How to Repay Your Loan of Borrowing Against Your Life Insurance Policy
Policy loans don’t have a set payback schedule like other loans. That does not, however, imply that you should completely disregard repayment. The following advice can help you manage repayment:
#1. Inquire About the Payment Process
Make sure you have all the necessary information on hand so you can pay on time when needed. Make careful to write down your insurer’s repayment address and account number. Your loan statements should have this information listed.
#2. Monitor the level of Interest.
Your coverage may terminate if the principal amount plus interest surpasses the cash value. You will now have to pay minimal interest to keep your insurance coverage in place.
#3. Prevent Policy Slippage
To prevent your coverage from lapse, make sure you pay your interest and premiums on time. The IRS will reclassify your loan as taxable income if you surrender it before repayment or if your coverage fails.
#4. Configure Recurring Payments
Consider using your checking account to set up automatic payments. By doing this, you’ll be able to prevent missing a crucial payment.
#5. Plan Ahead
Choose whether you want to pay back the loan in full, pay interest as it accrues, or do the absolute minimum to keep your policy from lapsing. Next, create a repayment schedule. Determine the frequency and amount of your payments to maintain your payment schedule.
#6. Notify Your Recipients
Tell your beneficiaries about your decision so they know what to anticipate. A much smaller death benefit can be taken by your loved ones if they are unaware of the loan or repayment schedule.
How much is a Million Dollar Life Insurance Policy a Month?
Depending on your age, health, annual income, policy type, and other considerations, the typical monthly cost of a million-dollar life insurance policy can range from about $50 to over $1,000.
How do rich people borrow from life insurance?
If your cash value rises to a certain level, you can withdraw from it or borrow against it. Your cash value itself still accrues interest if you take out a loan because, in essence, you’re borrowing money from the insurance provider.
How long does it take to build cash value on life insurance?
In two to five years, most permanent life insurance contracts start to build cash value. But before a noticeable increase in cash worth, decades may pass. Before applying, learn about the cash value predictions of the policy from a certified insurance agent.
How Soon Can I Borrow from My Life Insurance Policy?
To build up enough financial value to take out a loan against your life insurance policy, it usually takes five to ten years. The details of your insurance, such as your premiums and rate of return, will determine the precise duration.
Does a Life Insurance Loan Affect Credit Score?
Usually, taking out a life insurance loan does not affect the borrower’s credit score.
A cash-valued permanent life insurance policy may offer specific living benefits and death payout. Among these are the options to borrow against the policy’s cash value and to withdraw cash value. You don’t take money out of your policy when you take out a loan against it; instead, your insurer lends you the money and uses the funds in your policy as collateral. This implies that the cash value of the policy can keep growing. However, it’s crucial to inquire with your insurance provider about the calculation and payment of interest and any dividends if you have an outstanding loan.