No. Life insurance loans are based on your already accumulated cash value, so they do not require a credit check and they don’t affect your credit score.
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Borrowing against life insurance
Taking a loan out against your life insurance policy can be a valuable and flexible way to get money when you need it, but there are tradeoffs, and it sometimes isn’t the best option. Read on to learn all about life insurance loans.
Key takeaways:
- You can only borrow against the cash value of permanent life policies.
- Interest rates are typically lower than personal loans or credit cards.
- If not repaid, loans against your policy will reduce the death benefit.
Can you borrow against your life insurance policy?
If you are the owner of a life insurance policy, you can often take a loan out against it. This is sometimes called a life insurance loan. It is a flexible way to get money without a credit check that’s also usually tax-free; however, it does come with a number of drawbacks. To see if you qualify for a life insurance loan, your policy must first meet a couple important criteria:
1. It must be a permanent life insurance policy like whole life.
2. You must have built up cash value within the policy as collateral.
If that is the case for you, you can speak to your insurance provider or agent to see if you can start a loan. Interest rates will vary based on the policyholder and the particular details of your policy but are generally around 5%–8%. That’s better than some options like a personal loan or credit card, but worse than others like a home equity loan or line of credit.
What life insurance can you borrow from?
You can only borrow against permanent life insurance policies that have a cash value component. The most common type is whole life insurance, but universal insurance policies also often generate cash value. What is cash value? It’s the part of your policy that accrues value over time. With each premium payment on a permanent life insurance policy, it accumulates a little cash value growth. Over time, this can become quite significant.
Why can’t you borrow from term life insurance?
Term life policies are designed to protect you and your family for a specific amount of time, usually between a few and 30 years. This is commonly used to protect a mortgage or cover the expenses of children before they are able to set out on their own. Because term life insurance is not permanent and does not have cash value growth, you cannot borrow against a term life policy. However, you can sometimes convert your term policy into a whole life policy. It will then have and continue to grow cash value that can be borrowed from down the road.
Life insurance policy loan: Is it a good idea?
The cash value of your policy is there for you if you need it. Think of it as a way to provide versatility. It can be used to help pay down a mortgage, cover a major health expense, or send a child to college. However, withdrawing or borrowing from it does reduce the surrender value and death benefit of the policy until it is repaid, so it may not necessarily be your best option. You should always weigh your immediate needs against the future needs of your family and explore all of your options when you need some extra funds. In many cases, a home equity loan or line of credit can be a superior option than borrowing against your life insurance.
Life insurance loan pros and cons
When considering whether you should borrow against your life insurance policy, take into account the pros and cons of doing so and explore other options you might have. Here are some things to think about when borrowing against your life insurance:
Pros:
- Won’t affect your credit score
- No approval process
- Typically has lower interest rates than personal loans
- Tax-free as long as the policy stays active
Cons:
- The total loan balance reduces the death benefit and cash surrender value of the policy
- The amount you borrow will accrue interest daily
- Unpaid loan interest will add to the outstanding loan principle and also accrue interest
- Repayment is additional to your premium payments
- Can cause the policy to lapse if the loan exceeds cash value
- If you surrender a policy or it lapses, you may be subject to additional taxes1
- Could affect your premium guarantees
What happens if you don’t pay back a life insurance loan?
When you take a loan out against your life insurance, it immediately lowers the death benefit and surrender value of the policy. As you pay back the loan principal and interest, the death benefit slowly returns back to its original value. If you don’t pay the loan back, there are two things that are may to happen:
- If unpaid, interest will continue to accrue and add to your balance, and if the loan amount ever grows larger than the current cash value of the policy, it can cause your policy to lapse. If that happens, your policy can be canceled entirely and there may be tax implications upon the loan you took out. You also may find getting another policy more expensive, since you are now older.
- If the policyholder dies while the loan is not fully paid, any outstanding balance of the loan plus interest owed will be deducted from the death benefit before being dispersed to your beneficiaries.
How to borrow against your life insurance policy
If you do decide that borrowing from your life insurance policy is the best option to get needed money, then follow these steps:
Step 1: Contact your insurance company or your insurance agent directly. They will be able to advise you on your eligibility and options and get any paperwork that you may need to fill out.
Step 2: Carefully review the terms of the loan to ensure you fully understand the tradeoff you’re making.
Step 3: Once you complete the loan paperwork you can expect to receive the funds typically within a few to 15 days.
How soon can I borrow from life insurance?
You need time for the cash value component of your policy to grow in order to use it as collateral for the loan. Different policies grow cash value at different rates, but it generally takes at least 2 to 5 years to have enough cash value to borrow against it, and even then, you may not be able to get a sizable loan.
How much can I borrow from life insurance?
Every company and policy can have different rules to how much you can borrow against your life insurance policy, but it can never exceed your current cash value, or the policy will lapse (see above). Usually, any loan will never exceed 90% of your cash value accumulation, but it can also be considerably lower depending on your policy and how long you’ve had it.
Paying back your life insurance loan
Often, there is no set schedule for how quickly you must pay back your life insurance loan, but the longer it takes you, the more you will pay in interest. If you decide to take a loan out on your life insurance, you will want to ensure that you can make repayments in a timely manner to avoid excessive interest payments or a potential policy lapse. Also, keep in mind that the loan payments will be on top of your premium payments, which you must continue to pay as well.
Alternatives to borrowing from your life insurance
There are many other options you may want to consider before taking a loan out against your life insurance. If you own a home, a home equity loan or line of credit may potentially be a better option. You can also explore personal loans from your bank. Another alternative way is to borrow from your retirement savings account like a 401(k) if your specific plan allows it. In times of need, you can also potentially surrender your cash value life insurance. Each of these options has its own pros and cons, and they might not be obvious. A New York Life financial professional can help you unpack all of your various options and choose the path that has the least impact on your future.
Borrowing from life insurance FAQs
The interest you pay on a life insurance loan, typically around 5%–8%, is paid to the insurance company that issued your life insurance policy and the loan.
ince everyone’s situation and goals are different, this is too complicated a question to answer quickly. It can be a strategic option but comes with tradeoffs. It’s best to discuss your options with a qualified financial professional.
Insurance loans are typically lower than personal loans or credit card rates. They often fall between 5%–8% depending on the specifics of the loan.
Typically loans against life insurance are tax-free as they are not considered income. However, if the loan amount exceeds the cash value of your policy and the policy lapses, taxes might then be due on the loan.
The loan amount and any interest owed is deducted from the death benefit before it is distributed to beneficiaries.
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1If your policy lapses, or if you surrender it while you have an outstanding policy loan, you may be liable for federal or state income taxes if the value of the outstanding loan plus your cash surrender value is more than the total amount of premiums you have paid into your policy (less certain non-taxable distributions). New York Life will report any taxable gain to you, the Internal Revenue Service (IRS), and any applicable state taxing authorities. Please be sure to discuss this with your tax advisor.