How to borrow money against your life insurance policy
Some life insurance policies build cash value over time. Learn how you may be able to borrow money against that cash value.
Quick, what's the first thing that comes to mind when you think about borrowing money? If you're like most Americans, you likely thought of a bank or credit union. But there are other, lesser-known ways to borrow money. One of them is borrowing from your life insurance policy.
Depending on the type of life insurance you have, you may be able to get cash while you continue to protect your family and build wealth.
But it shouldn't necessarily be your go-to solution. “If you need a loan, you may not want to start with life insurance,” says Matt Lyon, a USAA Advice Manager who suggests first exploring more traditional methods through your bank.
Still, if borrowing against your life insurance is a path you're ready to explore, read on to learn about the type of life insurance that allows for policy loans.
Can you borrow against term life insurance?
It's often thought the most common type of life insurance is term insurance, which provides coverage for a specified period of time.
But according to a 2022 study conducted by LIMRA, only 34% of life insurance owners have term coverage. More than 51% of policy owners have permanent life insurance, and 15% have a combination of term and permanent.
For term policy owners, borrowing against their life insurance isn't an option, because there's no cash value accumulation with term life insurance.
Can you borrow against permanent life insurance?
So, if you can't borrow against term, you must be able to do so with permanent life insurance, correct?
“The short answer is yes, but it depends,” says Lyon. Most permanent policies have provisions allowing you to take a loan against the cash value. Those privileges are contractual in nature and depend on your insurer.
Given those caveats, let's discuss the options to help you decide what's best for your needs.
How borrowing against life insurance works
If you have a permanent policy and want to borrow against your cash value, it's a straightforward process. Unlike typical lending, which can involve a credit check, borrowing from your life insurer is a phone call away.
“That's because you're the owner, and the cash value is yours if you ever decide to cancel the policy,” explains Lyon.
The loan collateral is the cash value, making your life insurance company a willing lender. And if you die, any unpaid loan and interest will be deducted from your death benefit.
How soon can I borrow against my whole life insurance?
Like a savings account, the cash value in your policy needs time to grow.
“It's often mistaken that you borrow from your death benefit, but that couldn't be further from the truth,” Lyon says.
Why? Well, unless you die, the death benefit belongs to your life insurance company.
So, what belongs to you? The cash value balance.
“Remember, the main purpose of the cash value is for it to return to the policy owner upon cancellation,” says Lyon. This can also be referred to as surrendering the policy. But many people would like access to that cash without losing their life insurance coverage.
This is where the loan comes into play.
Because cash value grows according to the policy type, knowing when you can borrow is tricky. For example, universal life cash value won't grow the same as it will with whole life. To bring it back to the original point, the cash value needs time to grow.
It takes a mix of premium payments, interest rates and other factors for the balance to increase.
Here's an example of a 37-year-old female who has a whole life policy. She pays a $702 annual premium to get a $50,000 death benefit.
| End of Year | Premium Per Year | Net Cash Value | Death Benefit |
|---|---|---|---|
| 5 | $702 | $786 | $50,000 |
| 10 | $702 | $2,931 | $50,000 |
| 20 | $702 | $8,613 | $50,000 |
| Age 70 | $702 | $19,168 | $50,000 |
As you can see, she's not likely to borrow against $786 in cash value after five years. But as a 70-year-old, she'll have $19,168 to borrow against.
How much can I borrow against my life insurance policy?
It depends on how much is available. Some policies grow faster than others. For example, universal life and dividend policies may allow extra contributions or have higher crediting rates, which means you might be able to borrow sooner.
But are you allowed to borrow 100% of the cash value? “A lot of people think they can since it will be theirs someday anyway, but that's not exactly how it works,” says Lyon.
Like a personal loan from the bank, interest is charged on the loan amount. That's because you're borrowing from the life insurance company. The cash value is yours if you surrender your policy, not while it's active.
The interest can be fixed or variable. When fixed, there's usually a cap. For example, that could be 7% to 8% yearly. But this, along with how the interest accrues, depends on the company and contract.
A contract will say something like this:
"The maximum amount you can borrow is an amount that, together with the interest it accrues by your next policy anniversary, will equal the net cash value as of that date."
In other words, you can't borrow 100% of the cash value because the interest is calculated into the loan balance. Because of this, most life insurance companies will set a fixed limit, which could be up to 90% of the net cash value.
Things to consider when taking a loan against life insurance
Understanding a loan's provisions is important not only in choosing whether or not to borrow but also when deciding how to pay it back. Most companies won't provide a repayment schedule like you get with a traditional bank personal loan.
Paying back the loan is optional, but it's encouraged. Here's why. “If you cancel the policy, you've already borrowed the amount you would've received. If there's outstanding interest, it's subtracted from the remaining cash value,” Lyon explains.
If you don't pay the interest, your loan balance can end up being higher than the value of your policy, causing it to lapse. “Then you're out the life insurance you wanted in the first place,” he adds.
At the least, if you can keep up with paying off the interest balance, you'll keep the policy active while the remaining cash value grows.
In addition to the benefit of having cash on hand, your taxable income won't include the amount you borrowed. But if your policy lapses, you may have to include it. If that's a concern, be sure to talk to your tax advisor.
Should I borrow against my life insurance policy?
Whether it's the reason you purchased your policy or a choice you weren't aware of, borrowing from your permanent policy is an uncommon option worth considering. Determining if it's the best choice depends on your situation and the factors we've covered. To learn more, talk with a licensed life insurance agent or get a quote today.