Borrowing Against Life Insurance: When It’s a Good Idea and How to Do It

borrowing against life insurance

Borrowing against life insurance can help pay off a mortgage, cover medical bills, or supplement college expenses. But whether taking a loan against life insurance is a good idea depends on your policy type and why you bought a policy in the first place.

Life insurance policies can serve many purposes. You might have it as a type of “income insurance” to help support your family’s living expenses if the worst should happen. However, most policyholders—66% of Americans, according to LIMRA—use it to pass wealth onto future generations.

Is borrowing against life insurance a good idea? And can it change how your policy benefits your loved ones?

Can You Borrow Against Your Life Insurance Policy?

If you need an influx of cash, borrowing against life insurance can seem like a reasonable solution. You may have been paying the premiums for years—surely there’s some equity built up, right?

Not so fast. While some policies build cash value, some do not. Term and whole life are the two most common policy types, and only one lets you take a policy loan against it.

Borrowing Against Term Life Insurance

A term policy is valid for a specific number of years—usually five to 30 years. If you die before the policy’s maturity date, your beneficiary can receive an immediate payout.

Term life insurance policies are typically more affordable because they expire at a set time and don’t have a cash value component.

So, can you borrow against term life insurance? In short, no. And if you surrender the policy, you don’t receive any money in return.

Borrowing Against Whole Life Insurance

Whole life insurance, sometimes called cash-value life insurance, is a type of permanent life insurance that lasts the policyholder’s entire lifetime. It’s more complex than term, and you could pay five to 15 times more for the same death benefit.

But as you pay your premiums year after year, a whole life policy builds cash value that offers several advantages.

For example, when you reach enough cash value, you can use it to:

  • Buy more coverage to increase the death benefit
  • Pay policy premiums
  • Take a cash withdrawal that you may not have to repay
  • Borrow money, using the cash value as collateral

That means borrowing against whole life insurance is possible If you have enough cash value. In fact, the ability to borrow using your cash value as collateral is a significant reason consumers buy permanent life insurance, according to the Insurance Information Institute.

What Happens When You Borrow Against a Life Insurance Policy?

Each time you pay your whole life insurance premiums, part of your payment is set aside towards the cash value. The cash value grows slowly and accumulates interest according to the rate set by the policy’s terms.

So, how soon can you borrow against whole life insurance? As soon as there is cash value, usually from year three onwards, you can borrow against it. However, real growth can take longer to accumulate.

A policy loan is different from a bank loan or credit card advance. For example, taking a loan against life insurance doesn’t affect your credit, according to Experian. There also isn’t an approval process or credit check because you’re essentially borrowing money from yourself.

How Much Can You Borrow Against Your Life Insurance Policy?

How much you can borrow from your whole life policy depends on your life insurance company. Your policy may cap the amount of a loan against cash value life insurance.

For example, your provider may limit your loan to 90% of the policy’s loan value. However, most insurers allow you to take a loan for the total amount excluding the amount needed to pay the following year’s premium, with no minimum on how much you borrow.

But here’s the key: When you take out a policy loan, you’re not withdrawing your cash value. Instead, the insurer is giving you a loan and using your cash value as collateral. The advantage to this is that your cash value can remain with the policy and continue to collect interest and possibly dividends as well.

Should You Take a Loan Against Your Life Insurance Policy?

Before asking yourself, “Can I take a loan against my life insurance policy,” first ask if you should do it at all.

Pros and Cons of Borrowing Against Life Insurance

A loan against your life insurance policy can be an excellent way to get the cash you need. It has some advantages over using a credit card or bank loan.Pros and Cons of Borrowing Against Life Insurance Infographic

Still, borrowing against life insurance can be a quick and easy option to get money on short notice. Just be careful about managing the cash value amount and monitoring the accumulating loan interest.

When a Policy Loan Makes Sense

Despite the potential drawbacks of taking out a policy loan, it’s worth considering in some situations. For example, a policy loan might make sense if:

  • You don’t qualify for a standard bank loan.
  • You don’t want to use another asset as collateral.
  • You can afford to pay back the life insurance loan.
  • You want a flexible repayment schedule.

Even if borrowing against life insurance makes sense, remember that consequences exist. Review the pros and cons to make sure it’s the right financial move for you.

How to Borrow Against Whole Life Insurance

Now that you know it’s possible to take a loan against your life insurance policy, the next question is, “How do I borrow against my life insurance policy?”

The first step is to determine whether you can borrow from the policy. Remember that term life doesn’t build cash value or offer loans against the policy. But you could borrow against a whole life, universal, variable life, or variable universal life insurance policy.

Luckily, the process is straightforward:

  1. Fill out and submit a form from the insurer
  2. Confirm your identity and agree to the terms
  3. Provide account information to have the money directly deposited

There’s no application or credit check, and policy loans don’t have a specific repayment schedule. However, your insurer will charge interest so long as the loan remains unpaid. You can choose to pay the interest or have it added to your outstanding loan balance.

How Do You Pay Back Your Loan Against Life Insurance?

Borrowing against your cash value is one of the living benefits of life insurance. Unlike a typical credit card balance or personal loan, your insurance company won’t require you to repay a policy loan. Your cash value secures the amount you borrowed, although your insurer will charge interest on the balance.Living benefits of whole life insurance

You have the option to pay loan interest out of pocket or add it to the loan balance when borrowing against the cash value of life insurance.

The risk of accumulating interest is that your loan balance could become larger than your cash value. When this happens, your loan is “underwater” and poses a great risk to you and the insurance company.
If your balance is more than your cash value collateral, your policy could lapse. However, insurance companies typically offer several opportunities for you to keep the loan current and prevent lapsing.

But there’s another concern: If you pass away before you repay the loan, your loved ones won’t get the full death benefit. That’s because the insurer can subtract the outstanding balance from the payout amount, reducing the amount your beneficiary receives.

Borrowing Against Your Life Insurance Policy: The Bottom Line

Can you take a loan against your life insurance policy? Yes. For people who are short on cash, a policy loan could be an excellent alternative to racking up credit card debt or getting a personal loan.

But should you? It depends on your situation. It can make sense if you don’t qualify for a standard bank loan, don’t want to use your home or another asset as collateral, and want a flexible repayment schedule.

Remember that building enough cash value to borrow against could take years. And you can only create cash value if you have the right type of policy.

If you’re one of the 41 million Americans who say they need life insurance coverage but don’t have it, Sproutt can help.

We consider your goals and quality of life to match you with the type of life insurance that’s right for you. Contact our team of life insurance experts for the best life insurance coverage and price.

Get an instant online quote for life insurance.