Can You Borrow Against a Life Insurance Policy?


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ByMelissa Wylie
Edited byRae Osborn
ByMelissa Wylie
Edited byRae Osborn

Updated: May 22, 2024

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Borrowing against a life insurance policy is possible with certain types of permanent life insurance, such as whole, universal or variable life insurance. This financial strategy lets you secure a loan using the policy's value.

Although borrowing from your life insurance can serve as a strategic financial move, offering immediate access to funds with potentially favorable tax implications, it may not be suitable for everyone. Careful consideration of the process, benefits and risks ensures that a life insurance loan aligns with your financial goals and needs.

Key Takeaways

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Borrowing against a life insurance policy is possible with certain types of permanent life insurance, such as whole, universal or variable life insurance.

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Borrowing money from life insurance is a financial strategy that offers potential benefits like tax advantages and flexibility but carries risks such as reducing your death benefit and possible tax consequences if not managed properly.

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Understanding the process, regular repayments, interest accrual and the policy's terms can prevent a potential reduction in the death benefit and possible policy lapse.

Types of Life Insurance Policies You Can Borrow Against

Borrowing against a life insurance policy is limited to specific policy types. Here's a closer look at the life insurance policies that permit borrowing against their cash value:

  • Whole Life Insurance: Whole life insurance policies build cash value over time, allowing policyholders to borrow against this value. Borrowing from whole life insurance typically comes with favorable interest rates and provides flexibility in repayment terms.

  • Universal Life Insurance: Universal life insurance offers adjustable premiums, death benefits and the opportunity to borrow against the policy's cash value. This type of policy provides additional financial flexibility for policyholders.

  • Variable Life Insurance: Variable life insurance policies invest the cash value in various investment options, allowing for potential growth. Borrowing against this policy type requires consideration of market conditions and investment performance.

If you own one of these life insurance policies, borrowing against your policy may be a practical financial strategy, depending upon your need and situation.

How to Borrow Against a Life Insurance Policy

Borrowing against a life insurance policy is a financial strategy that differs significantly from traditional bank loans. Here's how the process works:

1
Understand the Difference From Bank Loans

Unlike traditional bank loans, life insurance loans usually offer more lenient application requirements and relatively low-interest rates.

  • No Credit Check Required: Since the policy's cash value secures the loan, most insurance companies don't require a credit check. This makes borrowing against life insurance more accessible.

  • Flexible Repayment Terms: Life insurance loans often don't have a fixed repayment schedule, allowing for more flexibility in how and when you pay back the loan.

2
Contact Your Insurance Provider

Most life insurance companies allow policyholders to request a life insurance loan online or by phone. It's typically a straightforward process, but having your policy details handy can help expedite the request.

3
Understand the Terms

Interest rates and fees may vary, so it's essential to understand the terms before proceeding. Key considerations include:

  • Interest Rates: These are typically competitive but can vary between providers.

  • Repayment Schedule: While flexible, understanding how interest accrues and any potential fees is essential to avoid impacting the life insurance policy you can borrow against. There may not be a strict timeline for repayment, but interest will continue to accrue unless you repay the loan.

  • Potential Impact on Death Benefit: If you don't repay the life insurance loan, it may reduce the death benefit payable to beneficiaries.

4
Receive the Funds

Once approved, the insurance company that holds the policy disburses the funds according to the chosen method. Options may include:

  • Direct Deposit: Funds can be transferred directly to a bank account.

  • Check: Some policyholders may opt to receive a physical check.

  • Applying to Premium Payments: You may want to use the insurance loan to cover future premium payments on the policy.

Understanding the process of borrowing against your life insurance policy is vital to empowering yourself financially.

Pros and Cons of Borrowing Against Life Insurance

Weighing the pros and cons of borrowing against life insurance is crucial for policyholders considering this option, as it can have significant implications for both the policyholder and beneficiaries. Here's a detailed look at the advantages and drawbacks:

Pros and Cons

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PROS
  • Tax Benefits: The Internal Revenue Service (IRS) generally doesn't recognize life insurance loans as income, which may offer tax advantages. The interest paid on a life insurance loan might not be deductible, but the loan itself is typically not subject to income tax. Additionally, if managed properly, the loan may not impact the tax-free nature of the policy's death benefit.

  • No Formal Approval Process: Since the plan's cash value is technically yours, there's no lengthy approval process.

  • No Effect on Credit: Life insurance loans will not affect your credit score.

  • Flexible Repayment Terms: Unlike other loans, life insurance loans don't have a set repayment schedule, allowing you to pay it back on a schedule that works for you.

  • Competitive Interest Rates: Life insurance loans often have more competitive interest rates compared to personal loans.

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CONS
  • Potential Reduction in Death Benefit: If you don't repay the loan before the policy owner passes, the beneficiary may receive a reduced death benefit.

  • Risk of Losing the Plan: It's important to make timely payments, as failure to repay the loan may result in losing the life insurance plan, especially if the loan amount plus accrued interest exceeds the policy's cash value.

  • Possible Tax Implications: There may be tax consequences if the life insurance plan lapses due to an unpaid loan. The outstanding loan amount may be taxable income, and the policyholder could be liable for income taxes.

  • Interest Accrual: While the rates on life insurance loans are often competitive, they do accrue interest. If the interest accrues at a faster rate than you repay the loan, your policy could lapse.

  • Restrictions on Borrowing: You generally need a minimum amount of cash value built up. Policyholders are also usually limited to a certain percentage of their cash value balance, often 90%–95%. Specific limits may vary by insurer.

Carefully considering the benefits and drawbacks of borrowing against your policy will help you decide if this strategy suits you.

When to Consider Borrowing From Your Life Insurance Policy

Borrowing against a life insurance policy can be a strategic financial move, but there may be better options depending on your situation. Evaluating individual financial goals can help determine if this option aligns with your needs.

You May Want to Borrow Against Life Insurance If:
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    Facing Unplanned Expenses

    If you encounter unexpected medical bills, home repairs or other unforeseen costs, borrowing against your life insurance may provide a timely solution.

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    Dealing with High-Interest Debt

    If you have high-interest loans or credit card debt, a life insurance loan may offer a lower interest rate, helping you consolidate and manage debt more effectively.

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    Poor Credit Situation

    If traditional loan options are unavailable or unattractive due to poor credit, borrowing against your life insurance policy may be a viable alternative, as it typically doesn't require a credit check.

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    Need for Flexible Repayment Terms

    Life insurance loans often provide flexibility in repayment terms, allowing you to choose a schedule that fits your financial situation.

You May Not Want To Borrow Against Life Insurance If:
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    Risk of Reducing Death Benefit

    If preserving the full death benefit for your beneficiaries is a priority, borrowing against a life insurance policy may not be the best option, as failure to repay the loan can reduce the payout.

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    Potential Tax Implications

    Lapsing the policy due to unpaid life insurance loans may lead to tax consequences, making this option less appealing if you're uncertain about repayment.

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    Investment Performance Considerations

    In the case of variable life insurance, borrowing against your life insurance policy requires consideration of market conditions and investment performance, as it may impact the cash value.

Borrowing against your policy at the wrong time or mismanaging your loan may reduce your life insurance's overall utility.

What to Do Before Borrowing Against Life Insurance

Before borrowing against a life insurance policy, you should learn about the process, eligibility and potential implications. Here are the key steps to take:

  • Verify Policy Type: Ensure that you have a cash value life insurance policy, such as universal or whole life insurance, as term life insurance does not allow borrowing against it.

  • Check Cash Value Threshold: Assess if the cash value has reached a certain threshold that permits borrowing. The policy may take several years to accumulate enough value for a policy loan or withdrawal.

  • Consider Conversion if Necessary: If you wish to borrow against life insurance but have a term policy, speak to your insurance agent to see if your policy qualifies for conversion to a permanent one without undergoing a new health exam.

  • Plan for Repayment: Consider how you will repay the life insurance loan, keeping in mind the interest accrual and potential impact on the policy's death benefit and cash value.

Proper planning before borrowing from your life insurance can help you make an informed decision, ensuring your financial strategy aligns with your goals.

Monitoring and Managing a Life Insurance Policy Loan

Proactive monitoring and management of a life insurance policy loan can help maintain the integrity of the policy and avoid potential pitfalls.

Regular Repayments
  • Paying on Time: Timely payments ensure the life insurance loan doesn't negatively impact the policy's cash value or death benefit.

  • Flexibility: Many life insurance loans offer flexible repayment terms, allowing policyholders to choose a schedule that fits their financial situation.

Understanding Interest Accrual
  • Interest Rates: Life insurance loans typically have competitive interest rates, but understanding how interest accrues is vital to managing the loan effectively.

  • Compounding Effect: Interest on a life insurance loan may compound, meaning it can grow over time if not addressed, potentially reducing the policy's cash value.

Awareness of Your Policy's Terms
  • Loan Limits: Know the maximum amount you can borrow against your life insurance without jeopardizing the policy.

  • Potential Fees: Some policies may have fees or charges associated with life insurance loans.

Regular repayments, understanding interest accrual and awareness of the policy's terms can prevent unexpected consequences.

What Will Happen if You Don't Repay

There are several consequences to failing to repay your life insurance loan. You may receive a reduction in your death benefit to your beneficiaries, as your provider may deduct the outstanding amount from your benefits. You may also face a policy lapse if the loan amount plus interest exceeds the policy's cash value, leading to a loss of coverage. It's important to be aware of the potential tax consequences as well. A lapsed policy due to an unpaid loan may result in the outstanding loan amount being considered taxable income, leading to tax liabilities.

Understanding the risks underscores the importance of managing life insurance loans with diligence and foresight, ensuring that borrowing against life insurance aligns with your long-term financial goals and protects the interests of your beneficiaries.

Alternatives to Life Insurance Policy Loans

While borrowing against a life insurance policy can be a viable financial strategy for some, it may not be the best option for everyone. These alternatives provide different ways to achieve financial goals:

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    Term Life Insurance

    Term life insurance is more affordable than permanent life insurance and doesn't have a cash value component. It provides coverage for a specific period, making it a more straightforward option for those seeking only life insurance.

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    Cashing Out or Surrendering the Policy

    If your policy has been active for a certain number of years, you may have the option to surrender it and receive the cash surrender value. This approach cancels the permanent policy, providing you with the accumulated cash value without taking a loan.

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    Traditional Loan

    Seeking a loan from a bank or other financial institution may be less complicated and risky than borrowing against your life insurance policy. Traditional loans don't introduce waiting periods or jeopardize the policy's payout, offering a more straightforward borrowing process.

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    Overloan Protection Rider

    If you're considering getting a policy loan but are concerned about potential risks, an overload protection rider might be an option. This rider ensures that your policy can stay active if you cannot repay the loan, although it may come with age restrictions and additional qualifications.

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    Investing in Other Financial Products

    Diversifying your investment portfolio with other financial products like stocks, bonds or mutual funds can provide financial flexibility without relying on life insurance loans. You may consult with a financial advisor to explore suitable investment opportunities tailored to your needs.

We recommend considering other options if you're concerned about the potential risks of life insurance loans.

FAQ: Life Insurance Policy Loans

Below are commonly asked questions to provide more information about life insurance policy loans.

Can I borrow money from my life insurance?
What type of life insurance can you borrow from?
Can I borrow money from my term life insurance policy?
How much can I borrow from my life insurance policy?
How soon can I borrow from my life insurance policy?
How can I borrow money from my life insurance?
When can I borrow from my life insurance?
What happens if you don't repay the loan?
Who gets the interest on a life insurance loan?
Can I use life insurance to buy a house?

About Melissa Wylie


Melissa Wylie headshot

Melissa Wylie is a Content and SEO Manager at MoneyGeek. Melissa has worked in the financial content space since 2018 and has spent much of that time focused on all things small business.

Prior to joining MoneyGeek, Melissa held SEO positions at Bankrate and LendingTree. Melissa’s work has also appeared on LendingTree-owned websites ValuePenguin and MagnifyMoney.

Melissa began her career at American City Business Journals in 2015 as a reporter for the company’s women-focused publication Bizwomen. Melissa has a Bachelor of Arts in Journalism from the University of North Texas. Melissa relies on her foundation in journalism to craft content that simplifies complex financial topics to help everyone feel confident when making decisions with their money.

Melissa's other work can be read on LendingTree and Bizwomen.