Whole Life Insurance Loan 101: What It Is & How to Use It

Whole policies cost a lot more than term life insurance, and policyholders get two main benefits in return. The first is that whole policies are permanent, meaning they last your lifetime (term policies lapse after a set number of years). The second is that they accumulate cash value over time — and you can use that cash value to your benefit. You can even take a whole life insurance loan against it.

But should you? That’s an entirely different story. Whole life insurance policy loans come with some distinct benefits, like being easy to get and relatively low-interest. But they also come with significant risks. To help you determine if this type of loan is right for you, let’s cover the basics.

Can I take a loan from my whole life insurance policy?

Yes. Because a whole life insurance policy is a type of permanent life insurance that accrues cash value, you can secure a loan using that cash value as collateral. Term life insurance isn’t eligible for this type of financing.

Using cash value for whole life insurance policy loans

Only permanent life insurance policies, including whole policies, come with a cash value component. As you pay your premiums, your insurance provider puts some of that money into a separate account. Then, that money grows.

The way your cash value grows depends on the type of permanent life policy you have. There are a few different types of permanent policies, including:

  • Universal policies, which grow your cash value at a money market rate of interest.
  • Variable policies, which invest your cash value and grow that account based on the investments’ performance.

The Insurance Information Institute (III) reports that whole policies are the most common type of permanent life insurance, so we’ll focus on these policy types here. What you need to know is that with whole policies, your insurance provider puts a portion of your premiums into an account where that money grows at a steady rate (e.g., 4%). That’s called your cash value.

Why does this cash value matter so much when it comes to life insurance loans? Because when you take out this type of loan, your insurance company uses the cash value as collateral for the loan.

Think of it this way. When you get a mortgage, your house serves as collateral. With a car loan, the vehicle acts as collateral. Basically, it gives the organization offering you the loan something they could recoup if you default on the loan.

The same goes for whole life insurance policy loans. The cash value acts as collateral, securing the loan. And that does mean that if you don’t repay the loan, you could lose that cash value. But we’ll get more into that later.

Getting a whole life insurance loan

In order to get this type of loan from your life insurance provider, you usually just need to do two things. First, you need to wait until your cash value accumulates. This usually means paying your premiums for at least five years so money can build up in that cash value account, which you can then use as collateral for your loan.

Once your cash value has accrued to a certain level, actually taking out the loan is fairly straightforward. Your policy provider will probably have you fill out a form and will let you know about the whole life insurance loan interest rate they can offer you. Once you agree to the rate and complete the paperwork, you can usually expect the loan funds to hit your account within a few days.

You don’t need to worry about a credit check, nor do you need to be concerned that the loan will affect your credit score. Your insurance provider handles the entire financing process privately, so there are no credit requirements or ramifications here. In fact, you can get this type of loan even with bad credit, assuming you have sufficient cash value to borrow against.

How does a loan from a whole life policy work?

Let’s go over some key details here:

  • Loan amount: You have the option to choose how much of your cash value you want to borrow against. If your cash value account has reached $50,000, for example, you could choose to only borrow half.
  • Whole life insurance loan rates: Your insurance company probably has set interest rates for these types of loans. The interest will accrue — and, at a certain point (usually each year), compound —just like it would with any other loan. That said, whole life insurance loan interest rates can usually compete with the best rates available today. So while you still need to worry about managing the interest, you can expect relatively low rates.
  • Cash value growth: When you take out this loan, you’re not actually withdrawing the cash value of your whole life policy. Instead, the cash value stays in your account and simply serves as collateral. That’s good news because it means your cash value can continue to grow even while you have the loan.
  • Repayment: Unlike most other loan types, your whole life insurance loan doesn’t come with a set amortization (i.e., payoff) schedule. You won’t need to worry about making monthly payments, for example. You can pay the money back when you want. But failing to repay the loan and its interest can come with some serious drawbacks. To make the most of this type of financing, most financial experts recommend going in with a set plan to pay off what you borrow.
  • Using the loan: Once you take out the loan, you can use the money however you want. You could use it to bridge a serious financial emergency, but you could also use it to take your dream vacation.

Ultimately, as far as loans go, whole life insurance loans offer some significant benefits. But there are potential drawbacks to consider, too. First, the good news.

What are the benefits of a whole life insurance loan?

Whole life insurance policy loans deliver some serious perks, including:

Low rates

In most cases, whole life insurance loan interest rates can compete with interest rates for the best loan options. They usually come in much lower than personal loan and credit card interest rates.

Less-critical collateral

You may reach a point where your death benefit serves more as a nice-to-have than a necessity. In that case, the whole life loan allows you to take out a loan with collateral on the line that wouldn’t hurt as much to lose as, say, your home or car.

Ease of access

You don’t need to worry about some extensive underwriting process to get this loan. In fact, it doesn’t even require a credit check. That means that even people with fair and poor credit can get a whole life insurance loan, assuming they have sufficient cash value associated with the whole life policy.

Beyond that, a whole life insurance loan comes with the perks we’ve already mentioned, like the fact that it won’t show up on your credit report, your cash value will continue to grow, and that it comes with a flexible repayment timeline.

What are the risks?

All this said, whole life insurance policy loans can come with some significant financial headaches if they’re not properly managed. This isn’t free money.

Let’s look at the three biggest risks associated with these types of loan.

Loss of the death benefit

If you don’t pay back your loan before you pass away, it doesn’t just evaporate. Instead, your life insurance company will deduct the outstanding loan amount (including any unpaid interest) from the death benefit they pay to your beneficiaries.

If you know your loved ones will need the entirety of your death benefit, you may want to think twice before borrowing against your whole life policy.

Policy lapse

Even during your lifetime, your whole life insurance loan could compromise your policy benefit.

This comes back to the fact that the cash value serves as collateral. If your loan accrues so much interest that it exceeds your cash value, your entire policy could lapse.

Basically, if you let so much interest accrue that it takes your total outstanding amount beyond your cash value, your insurance company will see that loan as underwater. At that point, they may (and probably will) let your policy lapse. That means losing your death benefit and any other benefits you may have attached to the policy. If you had a long-term care insurance rider, for example, you’ll lose that with your policy lapse.

Long story short, when you take out a whole life insurance loan, keep a close eye on the interest. It can be helpful to make a plan to continually pay the interest out-of-pocket to prevent a policy lapse, especially if you’re borrowing close to the full amount of your cash value.

Possible tax ramifications

If your policy lapses, you could get stuck with a big tax bill. At that point, the cash value amount you borrowed against can become taxable income in the eyes of the IRS. The main thing to watch is the amount of your outstanding loan compared to the premiums you’ve paid. Anything you get out of the policy above what you’ve put in (in the form of premium payments) could get taxed.

Pros and cons recap

So you can quickly review the basics, here are the main pros and cons of whole life insurance policy loans:

Pros and Cons recap-infographic

What is the interest rate on a life insurance loan?

That depends entirely on your life insurance provider and the policy you hold with them. For example, a MassMutual whole life loan interest rate and a State Farm whole life policy loan rate likely won’t be the same. The best way to find out what interest rate you’d pay is to check with your provider.

That said, we can give you a ballpark idea of the interest rate on whole life insurance loan options. In most cases, you’re looking at a rate somewhere between 1 and 9%, probably comparable to or below what you’d pay for a personal loan.

Ultimately, a whole life insurance loan can give you funds when you need them at a reasonable interest rate. And you can repay what you borrow on your own terms, too.

Just keep a careful eye on that interest. Most finance professionals recommend paying it off periodically to prevent a policy lapse and tax burden. And keep in mind that any outstanding loan balance can be subtracted from your death benefit, leaving your loved ones with less than you had planned.

If you have any questions about whole life insurance policy loans or the best type of life insurance for you to protect those who matter most, don’t hesitate to contact our team of experts here at Sproutt.

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