The primary reason for purchasing life insurance is usually to protect your loved ones financially if you die. But in some cases, you can also take out a loan through your policy while you’re still alive.
You can only borrow against your policy if you have permanent life insurance, such as whole, variable or universal life. That’s because with this type of coverage, part of your monthly premium goes into an account that builds up cash value — something that doesn’t happen with term life insurance.
[Life insurance quotes are available through NerdWallet’s Life Insurance Comparison Tool.]
Benefits of a cash value loan
Taking out a loan against your life insurance policy is different than taking out a loan at a bank. For one thing, it’s a lot easier. There is no loan application process and no need to check your credit history.
When you borrow against your policy your insurance company lends you money and your cash value becomes the collateral. “You’re borrowing against your own money, ” says Guy Baker, managing director of Wealth Teams Solutions in Irvine, California.
Until you’ve paid off the loan plus interest, what you owe will be deducted from the death benefit.
Has the policy accumulated enough cash value?
Before borrowing against your life insurance policy, it’s important to know how much money is available. Only some of your insurance premium goes toward cash value, so the money doesn’t accumulate as quickly as you may think.
If you’ve only had the policy for less than five years, you probably won’t have much money available to borrow against. In this case, you might have to consider other options such as a personal loan.
On the other hand, if you’ve had your policy for many years, you may have built up enough cash value to allow you to borrow the amount you need. Check with your insurance company to find out on your exact cash value amount.
How to request a loan
Once you’re ready to request a loan from your insurance company, you can look for a loan agreement form on the company’s website or call to ask for a loan over the phone. Some insurance companies require a phone-authorization form on file beforehand, so you might want to ask about this ahead of time.
Typically a check will be mailed to you or the funds will be deposited into your bank account within a few days.
Long-term effects on your policy
Be aware that the amount you borrow continues to grow because of interest; the interest rate depends on the type of policy you have. If the amount owed equals or exceed the policy’s cash value, and you stop making your regular premium payments, you risk a lapse in your policy. This could mean a loss of the death benefit, and you might have to pay taxes on part of the loan proceeds.
Consult your financial advisor or insurance company to learn more about the tax implications of borrowing against your life insurance policy and determine whether such a loan is right for you.
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