Step-by-Step: Loans Against Life Insurance Plans

What is a Loan on Life Insurance Policy?

Individuals can choose different types of loans for long-term financial security. One such option is a life insurance loan, which differs from regular options. This type allows you to borrow against the cash value of your permanent life insurance policy, which serves as collateral.

The loan amount is typically what you'd receive as a maturity benefit. Unlike term life insurance, this option is only available with permanent policies. While you don’t need to repay the loan, the insurance provider will charge interest on the borrowed amount. The outstanding loan may reduce the payout or cash value if not repaid.

What are the Advantages of Taking a Loan from Life Insurance?

Detailed below are the benefits of taking a loan from a life insurance policy –

• No collateral required - Under this type of loan, your policy’s cash value serves as collateral, so no need to provide anything extra.
• No additional fees - Unlike traditional loans, these plans have fewer fees. Moreover, you pay a low interest rate compared to other financing options.
• Easy approval - Life insurance loans are typically approved quickly with minimal paperwork.
• No usage restrictions - You can use this type of loan for any purpose such as funding a down payment of another loan, which may not be allowed with other loans.
• No repayment schedule - There’s no fixed timeline for repayment as long as the loan doesn’t exceed the policy's cash value and you continue paying premiums.

How Does Life Insurance Loan Work?

Unlike a bank loan or credit card, life insurance policy loans don’t affect your credit score. No approval or credit check is needed since you're borrowing from your policy. You can use the loan for anything, whether it’s bills, vacations, or emergencies, without explaining your purpose. 

Although the loan needs to be repaid with interest (which is usually lower than bank loans or credit cards), there’s no requirement for monthly payments.

When to Take a Loan against Life Insurance?

While you can take a life insurance loan when you need funds, it's always a good idea to first understand where it may be useful —

• Emergency Funds or Loan Ineligibility: If you're struggling to get approved for a traditional loan or need fast cash for medical bills or emergencies, a life insurance loan offers a quick solution. Unlike standard loans, there's no lengthy approval process.
• High Interest on Other Loans: These loans typically have lower interest rates and no strict repayment schedules, making them a cost-effective alternative to standard loans.
• Can't Afford Premiums: If you're struggling to pay your life insurance premiums, a loan can help you maintain coverage (as long as the loan doesn't exceed the policy's death benefit).

How to Borrow against Life Insurance?

Life insurance loans are available when the policy has enough cash value, typically allowing you to borrow 90% to 95% of that value. Keep in mind that each company sets its limits. 

There's no required repayment schedule since paying back the loan is optional. You can either pay the interest yearly or borrow the interest, but this will cause the loan balance to grow over time.

To understand the effects of a loan, request an annual in-force policy illustration. This should include different scenarios, such as repaying the loan, paying premiums and interest, borrowing future premiums, and keeping premiums the same to see how the policy will mature.

How to Repay Your Loan on a Life Insurance Policy?

Loans against life insurance policies can be repaid in three ways:

• Cash - You can repay with cash payments to the insurance company, which increases both the policy's account value and death benefit by the amount paid.
• Policy Value - If your policy's cash value is high enough, you can use this excess value to repay the loan. However, be cautious when repaying this way to avoid reducing the policy's overall benefits.
• Death Benefit - If the loan is not repaid during your lifetime, the outstanding balance will be deducted from the death benefit. This results in a reduced payout to your beneficiaries.

What are the Things to Remember When Taking a Loan Against Life Insurance?

If you're considering a life insurance policy loan, here are some key points to keep in mind:

• Check Eligibility - Ensure your policy qualifies for a loan. The loan amount depends on your policy’s cash value, but it won’t equal the full cash value. Confirm with your provider how much you can borrow.
• Document Requirements - Once eligible, ask your insurer about the necessary documents for the loan application, such as policy details and proof of income.
• Interest Rates - You'll need to pay interest on the loan, which varies based on your premiums. Higher premiums typically mean lower interest rates.
• Continue Paying Premiums - Keep paying your life policy premiums to avoid policy cancellation. Failure to do so could result in losing the loan.
• Approval Process - Loan approval may take some time, so be patient.