Borrowing Against Life Insurance – What You Need to Know
Whole life insurance costs more than a term policy, with the average 30-year-old paying $361 per month. Although it costs more, benefits include borrowing against life insurance when you need extra funds. You should thoroughly understand your policy before you borrow against your life insurance.
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Alexandra Arcand is an outreach administrator and insurance expert located in North Central Ohio. She has a passion for writing, investing, and education. As an insurance content writer for over three years, Alexandra has first-hand experience in business finance, economics, and real estate. She leads an outreach writing team that specializes in travel, real estate, healthcare, law, finance, an...
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Updated January 2025
One of the best permanent life insurance perks is that you can borrow against your life insurance policy. While borrowing against life insurance is impossible if you have a term policy, you’ll be able to take a life insurance loan from whole and universal policies.
Most companies allow you to withdraw funds from your policy’s accumulated cash value for any reason and without an approval process. However, permanent life insurance is much more expensive than a term policy, so it’s important to way your options. Read on to learn if borrowing against your life insurance plan is worth the extra costs. Then, compare term and permanent life insurance rates and policy options to find the right coverage for your financial needs.
- Permanent life insurance allows you to borrow against your policy
- Term life insurance is cheaper, but you can’t borrow from it
- You can request a life insurance loan for any reason
Types of Life Insurance You Can Borrow From
Not all life insurance policies allow you to borrow against them. Only those with cash value components are eligible for this kind of lending because the cash value acts as collateral. Two types of policies you can borrow against are whole life insurance policies and universal life insurance policies.
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How Borrowing Against Life Insurance Works
As mentioned earlier, the loan is taken against the cash value of your policy. This does not mean you are cashing out the policy itself. Your insurer lends you the sum of money you requested while they hold the cash value of your life insurance policy as collateral for the loan.
The loan can only be given to you as the policy owner; beneficiaries of your policy are not entitled to the same. Naturally part of the process of getting this loan involves verifying that you are the owner of the policy. Your insurer will help you figure out how much you can borrow and at what interest rate before giving you a forms to fill out. After selecting how you would like to receive the money, the lending process should be done in a matter of days.
Benefits of Borrowing Against Life Insurance
The process of applying for normal bank loans can be tedious and quite demanding. Even when everything checks out, there is always the possibility that the credit officer at your bank will turn you down for subjective reasons.
Borrowing against your life insurance policy is more certain, you usually will not need the usual credit checks that banks use. They do not even need to know what the money is meant for. Why? The cash value of your policy acts as collateral. Even if you do not pay back your loan, your insurance company is assured they will get their money back. This can be a great lifeline when you need money urgently.
- This kind of loan does not affect your credit rating even if you do not pay it back.
- Compared to bank loans, loans against your policy have friendlier interest rates because of their low-risk nature. Your insurer is sure they will get their money back either way.
- Unlike normal bank loans, borrowing against your policy generally does not have any fixed timeline for repayment.
- Withdrawals from whole life policies and universal life policies are exempt from taxes. Loans against your policy fall under this category of “withdrawals.” Therefore, borrowing against your life insurance policy is exempt from taxes.
Disadvantages of Borrowing Against Life Insurance
The main objective of getting a life policy is to leave a safety net for your loved ones in the event that you die. If you borrow against your policy and become deceased before repaying your loan, you are eating into the benefit they would receive.
Due to the lax nature of the loan repayment structure of this kind of loan, it is very easy not to pay your interest owed every year. While interest rates might be low, failing to pay can quickly compound the amount of money you owe. When that figure exceeds the cash value of your life insurance policy, your policy could lapse and get canceled. Insurers are generally more forgiving than banks with loans and tend to give their clients opportunities to make things right, but the risk of losing your policy should not be ignored.
There’s a caveat to the “tax-free” rule on borrowing against your policy. The rule only applies when your policy is intact. So, if your policy lapses before you complete repaying your loan, your loan becomes a taxable event. That can be expensive and ugly depending on how much you have borrowed.
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Life Insurance Loan Limits
In theory, your insurer will allow a maximum of the cash value of your life insurance policy. The reality is quite different. Once you factor in interest rates and other fees for processing the loan, they usually let you borrow up to 90% of the cash value of your life insurance policy. But, even that is not a certainty. Each insurance company has their own unique policies on how to handle this kind of loan.
When You Can Borrow Against Your Life Insurance
Since you cannot borrow more than the cash value of your policy, the first thing to consider would be whether the cash value of your policy at least matches the amount you would like to borrow. Remember the cash value takes time to build up, usually years. Some insurers have a minimum waiting period before you are allowed to borrow against your policy. Assuming there is no stipulated waiting period, you should be able to borrow against the policy as long as it has a large enough cash value to match the amount you would like to borrow.
Life Insurance Loan Repayment
Since you are effectively borrowing from yourself, there isn’t any specific time by which you are expected to clear your loan. With that said, you are still required to pay your insurance premiums.
Not paying your premiums and the compound interest accrued on your loan can eat into your policy benefits faster than most people realize. Left unchecked, this may exceed the cash value of your policy, which may then cause your life insurance policy to lapse. Let’s not forget that your lapsed policy may trigger a hefty tax penalty on the cash value of your policy.
It is safer to pay as much as you can as soon as you can to make sure your loved ones are still entitled to their benefits in the event of your death.
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Tax Implications of Borrowing Against Life Insurance
There are no tax implications of borrowing against your life insurance policy. However, if your policy lapses before you complete your loan repayments, a tax penalty is incurred on the cash value of your policy.
Alternatives to Borrowing Against Life Insurance
Withdraw from your Roth IRA
Unlike most retirement accounts, you cannot borrow against your Roth IRA and IRA accounts. Instead, what you can do is withdraw money from your Roth IRA. The sum withdrawn is tax-free if you reinvest it in 60 days or less. If you do not, you incur a 10% penalty on the sum you have not reinvested. It is a great option if you need cash you are sure you will return in 60 days or less. Think of it as a quick interest-free loan.
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Use a 401(k) loan
Note that not all 401(k) accounts allow this kind of borrowing. Also, this is not a loan in the traditional sense of a bank loan. It is more like withdrawing money from your retirement account tax-free with the promise to reinvest the amount borrowed plus a predetermined interest. So, even if you pay interest, it goes back into to 401(k) and not to a bank or other lender. You are effectively borrowing from yourself. The only problem with these is that losing your job or changing jobs before you repay the amount triggers a 90-day period in which you are expected to pay the remainder in full. If you do not, the unpaid amount becomes taxable, and you incur an extra 10% penalty.
Home Equity loans
Homeowners have access to secured loans in which they use their homes as collateral. They are simple and straightforward provided you own the property you are using as collateral. The interest rates are cheaper than other consumer loans. However, defaulting on these could lead to you losing your home or property.
Frequently Asked Questions
What types of life insurance policies can you borrow against?
Only those with cash value components are eligible for this kind of lending because the cash value acts as collateral. Two types of policies you can borrow against are whole life insurance policies and universal life insurance policies.
How does borrowing against life insurance policies work?
The loan is taken against the cash value of your policy. Your insurer lends you the sum of money you requested while they hold the cash value of your life insurance policy as collateral for the loan.
Are there benefits to borrowing against your life insurance policy?
The process of applying for normal bank loans can be tedious and quite demanding. Borrowing against your life insurance policy is more certain, you usually will not need the usual credit checks that banks use. They do not even need to know what the money is meant for. Why? The cash value of your policy acts as collateral. This can be a great lifeline when you need money urgently.
What are some of the drawbacks of borrowing against your life insurance policy?
One of the main disadvantages of borrowing against your life insurance policy is that you are essentially borrowing against your future death benefit, which can reduce the amount of money your beneficiaries receive when you pass away. Additionally, if you don’t pay back the loan, you could lose your policy.
Is there a limit to how much I can borrow against my life insurance policy?
Yes, there is a limit to how much you can borrow against your life insurance policy. The amount you can borrow depends on the cash value of your policy and the terms of your insurance company.
Can borrowing against my life insurance policy affect my credit score?
No. Borrowing against your life insurance policy does not require a credit check and does not affect your credit score.
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