The Basics of Life Insurance Loans

During times of financial hardship, a permanent life insurance policy may provide a solution. In addition to paying a death benefit, this type of insurance accumulates a cash value that you can use while you're alive. You could withdraw money from the cash value to cover your expenses, or you could take advantage of a policy loan. Life insurance loans allow you to borrow against the cash value of your policy and can be beneficial for covering expenses, provided you weigh their benefits and drawbacks carefully.

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What Are Life Insurance Loans?

Life insurance loans or policy loans are a type of lending agreement and use your permanent life insurance policy as collateral. When you apply for the loan, you pledge the policy. A lender will give you a lump sum equal to a certain percentage of the cash value. Most lenders won't allow you to borrow more than 90% of the value. In exchange for receiving the loan, you agree to pay interest, so the amount you ultimately repay is more than what you received.

Benefits of Life Insurance Loans

Life insurance loans have many potential benefits.

No need to repay. With a life insurance loan, you usually never need to make a payment on the principle. When you die, the lender receives repayment from the cash value. If more money is needed to repay the debt, the death benefit is reduced accordingly.
No credit check. Life insurance loans normally don't involve a credit check. Many lenders don't report them to the credit bureaus, so they may not impact your credit score.
No income verification. Because lenders are guaranteed repayment by the life insurance policy, you typically won't have to prove your income. In fact, a complete lack of income usually won't prevent you from getting a policy loan.
Favorable interest rates. Compared to credit cards and unsecured personal loans, life insurance loans normally have lower interest rates.
Retention of cash value. Borrowing against life insurance keeps your cash value intact. If you pay off the loan, the cash value will remain.

Disadvantages of Policy Loans

Life insurance loans do have some drawbacks that you need to understand before you apply for one.

Reduction in death benefits. If you're unable to repay the loan, your beneficiaries will receive less money when you die. This could make it difficult for them to maintain their standard of living, pay your final expenses and settle your debts.
Interest payments. Life insurance loans may require you to pay the accumulated interest on the loan. Depending on how much you borrow, these payments may be high.
Lack of access to cash value. You won't be able to make withdrawals from the cash value of your policy until you pay off the loan. If you need money in the future, you can't rely on your life insurance.
If you don't make any payments, the total borrowed amount will continue to increase. Should the total amount owed become large enough to exceed the cash value of your policy, you may have to pay taxes because the IRS could consider the additional money to be income.

Can You Borrow Against a Life Insurance Policy?

If you have whole life insurance, you're likely able to borrow against the cash value of your policy. Because term life insurance doesn't have a cash value, you normally can't use it as collateral for a loan.

What Is the Average Interest Rate on a Life Insurance Loan?

Interests rates for policy loans vary based on what type of loan you are acquiring, current rate trends and which lender you use. One large life insurance company reports that the average rate is 8% to 10% as of October 2021.

Should I Borrow Against My Life Insurance?

Ultimately, you'll need to weigh all the available options before borrowing. A policy loan may be your best option in the following circumstances:

You need money quickly. Because the underwriting process is simple, life insurance loans often receive approval fast. Typically, funds from a policy loan are available within one to 15 days.
You are stuck waiting for approval on another loan. Approvals and closings on mortgages and other secured loans can take weeks or even months. If you need money in the meantime, you may want to take out a policy loan to cover your expenses. Then, you can use funds from the new loan to pay off the life insurance loan.
You have a low credit score or lack income. If you don't meet the criteria for approval for other types of lending, a policy loan may be your only option.
You're struggling to pay your premiums. You can use the funds from a policy loan to pay monthly premiums so that your policy will remain in effect.

When Is It Better to Surrender a Life Insurance Policy?

When you surrender a whole life insurance policy, you give up the death benefit, which lets you receive the cash value and stop making premium payments. You may want to consider this option if you no longer need the death benefit provided by the policy. For example, if your only living relative has passed away and you don't have many debts to settle, surrendering your policy may be a better option than taking out a loan.