Most people get a life insurance policy so that their family can receive financial support, in the event they pass away. Depending on your policy, you may also be able to borrow money from your insurance coverage during your lifetime.
Keep in mind, borrowing money from your life insurance is still borrowing, which means that it eventually needs to be paid back. If you’re wondering about the pros and cons, and how much you can borrow from your life insurance policy, you’ve come to the right place.
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Types of life insurance policies you can borrow from
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There are different types of life insurance policies. The two most common types are term life insurance and permanent or whole life insurance.
A permanent life insurance policy is one that has no expiry date. When the premiums you’ve paid into the policy exceeds what is needed to cover the death benefit, the insurer will start investing that money, creating a cash value. This cash value acts as a savings account and is one that you can borrow against.
On the other hand, term life insurance policies are provide coverage for a fixed number of years, usually between 10 and 30 years. They do not provide a cash value and hence cannot be used to borrow money.
When can you borrow against your insurance policy
Be smart about choosing the right insurance company. Each insurer has its own rules about when you can borrow money from your life insurance policy. Some allow you to borrow money as soon as you build up cash value. Others may require you to wait a few years before you can take a policy loan.
In most cases, the waiting period does not exceed two years. The good news is besides the initial waiting period, there are no other time restrictions. You can request a loan at any time of the year, whenever you want.
How much can you borrow and how is it calculated
How much you can borrow from your life insurance policy depends on your insurer and it varies from company to company. Usually, you can borrow about 90% – 95% of the cash surrender value of the policy. In most cases, the amount you can borrow depends on the loan interest rate.
For instance, if the loan interest rate of your policy is 5%, the maximum loan you’re allowed to borrow may be 95%. Your insurer can keep the maximum loan amount below 95% as well. Generally, most companies do not set their maximum loan amount below 90% of the cash surrender value.
This calculation makes sure that the total annual interest (when added to your borrowed amount) is still less than the cash surrender value of your life insurance policy.
Advantages of borrowing from your life insurance policy
There are quite a few advantages to borrowing against your policy, such as:
- No questions asked – Whether you need money to pay your bills or go on a vacation, you can borrow from your life insurance policy with no questions asked.
- No application process – There is no long process. You usually fill out a form and collect the money.
- Low-interest rates – Policy loans often have lower interest rates compared to bank loans.
- No repayment schedule – There is no repayment schedule and you can pay back the loan as you like.
- Tax-free – You don’t have to pay tax in most cases.
Disadvantages of borrowing from your life insurance policy
There are some cons of borrowing money from your life insurance as well. These include:
- Money may not be available when you need it – Sometimes it may take years to build a cash value.
- Reduced death benefit – If you don’t pay the loan during your life, it may affect your death benefit.
- Policy lapse – If your interest and loan grow bigger than your cash value, you may lose your coverage.
- Tax – If your policy lapses, the loan plus interest is considered as taxable income.
If you have a whole life insurance policy and prefer simplicity, borrowing money from your life insurance policy may be a great idea. But before deciding to borrow against your policy, consider all of the pros and cons. Also, talk to a life insurance advisor to better understand your financial needs. Finally, have a plan from the start to repay your loan if you want your beneficiaries to get your policy’s full death benefit.