A life insurance policy could help you protect your family’s finances after you pass away. But did you know some policies could also provide additional support if you need extra money during your life? If you have a costly medical emergency, your child is going to college, or you want to start a new business, borrowing against your life insurance policy could help you secure the funds you need.

However, a life insurance loan could have major consequences for your coverage. This article will provide more information about borrowing against life insurance, but it’s always important to speak with your insurer or a financial professional before taking out a loan.

How do you borrow from life insurance?

Borrowers don’t have to undergo an approval process for life insurance loans like they would for personal loans from the bank. But if you want to borrow against your life insurance policy, you may have to submit a form to your insurer.

You can typically borrow against your life insurance if you have a permanent policy with a cash value component, like whole life. When you take out a life insurance loan, a portion of your policy’s cash value acts as collateral. Therefore, you can only take out a loan against your life insurance policy once your cash value has reached a certain threshold. If you pass away before repaying the loan, your policy’s death benefit could decrease by the amount you still owe.

Pros and cons of borrowing against a life insurance policy

While borrowing against your life insurance policy could help you in challenging financial situations, it’s not always the right option. Understanding the advantages and drawbacks could help you make the best decision for your unique circumstances.

Pros

• No credit check or other qualifiers. Most loans require an intensive application process, with a credit check that could impact your credit score. You don’t need to undergo a credit check or a time-consuming application when you borrow against your life insurance policy.
• Low interest rates. Life insurance loans usually have a lower interest rate than credit cards or unsecured personal loans. With your cash value as collateral, life insurance loans present a lower risk for your insurer than many personal loans do for banks.
• Flexible repayment. You can repay your life insurance loan whenever you want to; you set the pace.
• Not usually taxed. The IRS usually doesn’t consider life insurance loans a type of income, so they’re generally not taxable. However, this has some exceptions. A financial professional can help you understand your life insurance loan’s tax implications.

Cons

• Limited by cash value. You can borrow only up to a certain percentage of the cash value that your life insurance policy has accrued. Different life insurance policies accumulate cash value at different rates, but you may not have enough cash value to take out a loan for a decade or more after the policy begins.
• Possible reduction of your death benefit. If you pass away before you repay your loan, the remaining principal amount and interest could be taken from your beneficiary’s death benefit, leaving them with less financial support than you intended.
• Could put policy at risk. While you can’t be penalized for failure to repay a life insurance loan, in some cases, it could put your policy at risk. Interest rates on your loan compound each year, meaning your life insurance coverage could lapse if the total amount you owe exceeds your policy’s cash value.
• Might lose benefits from riders. Your life insurance loan may deplete the amount set aside for extra features or benefits, like an accelerated death benefit rider.

Alternatives to taking out a life insurance loan

If taking out a loan against your life insurance policy doesn’t seem like the right fit for your circumstances, you have other options.

Instead of taking out a loan against your life insurance policy, you could withdraw from its cash value. In that case, you wouldn’t have to repay anything. Withdrawals permanently reduce your death benefit, so this could be worth considering if you no longer need as much coverage.

If your financial circumstances or life insurance needs have changed, you might also consider swapping out your permanent policy for a more affordable term life policy. When you surrender or cancel your permanent policy, you could use its cash value to buy a term life insurance policy. That way, you can reduce expenses and still protect your loved ones.

Get a professional opinion before borrowing against life insurance

Borrowing against your life insurance policy is a serious decision that could significantly impact your coverage. Before you take out a loan, it’s a good idea to consider alternatives and speak with a professional. Call Fidelity Life today to speak with a licensed life insurance agent who can help you understand your life insurance options.

FAQs about borrowing from life insurance

How soon after getting life insurance can you borrow from it?

Your insurer may have specific guidelines about when you can borrow from your life insurance policy. Typically, you can only borrow up to a certain percentage of your policy’s cash value, so you may have to wait many years for your policy to reach that threshold.

Do you have to pay back what you borrow from life insurance?

Technically, no, you don’t have to pay back what you borrow from life insurance. However, the total amount you owe, including interest, may be deducted from your death benefit when you pass away. If that amount ever exceeds your policy’s value, it may lapse.

How much interest will you pay on money borrowed from life insurance?

Your interest rate on money borrowed from life insurance depends on your provider. Usually, life insurance loans have lower interest rates than personal loans from the bank.

Do you have to pay taxes on a life insurance loan?

In most cases, you may not have to pay taxes on a life insurance loan. However, your circumstances may differ. Speak with a financial professional for more information on life insurance loan taxes.