In the US, six in 10 adults already own some form of a life insurance policy. However, many of them aren’t that satisfied with their existing policies. In fact, 20% of policyholders say that they need more coverage.
In any case, the figures above show just how crucial life insurance has become to consumers. After all, this type of insurance plan can provide more than a lump-sum death benefit. Nowadays, borrowing against life insurance policies has become a common practice.
You read that last bit right — you can borrow or withdraw money from your very own life insurance plan! Meaning, you can be as healthy and fit and still benefit from your insurance policy.
Ready to learn when and how to borrow against your life insurance policy? Then let’s get right into it!
When Can You Borrow Against a Life Insurance Policy?
If you have a permanent life insurance policy, then it likely has a cash value component. Cash value life insurance policies are those that you can borrow against. These include whole life, universal life, and guaranteed life insurance, among others.
What’s Permanent or Cash Value Life Insurance, Anyway?
Cash value insurance policies are permanent, which means that they won’t expire. Your beneficiaries will receive the death benefit, regardless of when you pass away. So long as you make the premium payments, your permanent or cash value policy shouldn’t lapse.
Also, the longer you keep paying for your life insurance plan, the more cash that it builds up. This cash is a portion of the premium payments that you make monthly, quarterly, or yearly.
Over time, you’ll have enough cash that you can then withdraw or borrow from. Depending on your insurance provider, you may be able to take out a loan against your policy after ten years or so. Your insurer will use the cash value as collateral for the loan.
You can also use your policy’s accumulated cash value to pay your premiums. You can even use it to extend your coverage for a higher death benefit.
All these extra features are the top reasons whole life policies cost more than term life.
Keep in mind that term life insurance has an expiration date — it can be 10, 15, 20 years, or longer. In addition, no matter how long your term policy is, it will never accumulate cash. However, your life insurance company may allow you to convert your term policy to a permanent one.
That said, consider buying whole life instead of a term policy if you don’t have life insurance yet. This way, you can rest assured that you’ll receive coverage for life. At the same time, a permanent life insurance policy will offer you an additional source of funds.
Withdrawing vs. Borrowing Against Life Insurance Policies
There are two ways that you can tap the accumulated cash value of your whole life insurance policy.
The first is to withdraw from it, which is pretty much like withdrawing from a bank account. You have the option to pay back the money you withdrew. You should do this, as not paying it back may result in a reduced death benefit.
The second method is to take out a life insurance loan against your policy. Since it’s a loan, you can expect to pay interest on top of the principal loan amount.
At the same time, you may be able to get a bigger amount of money if you take out a loan. Withdrawing from a cash value policy often comes with a pre-set amount limitation.
The Advantages of Taking Out a Policy Loan
In 2019, more than one in four people in the US encountered a financial emergency. Such unexpected events led to an average $3,500 expense.
If you find yourself in a similar situation, you may not be able to withdraw that much from your cash value policy. You may, however, have enough cash value to take out a policy loan instead.
The availability of cash when you need it is only one of the perks of a policy loan. Here are the other reasons to borrow against your policy rather than from another lender.
No Lengthy Application Processes Involved
There’s no lengthy application process when borrowing against life insurance. You only have to fill out a form, hand it to over to your insurer, and wait for the money.
Whereas processing traditional loans can take several days to weeks. If you need cash as soon as possible, waiting for that long isn’t something you can afford to do.
It’s easier to take out a policy loan than a traditional personal loan, as you already have collateral. Your insurer will use your policy’s accumulated cash value as security for the loan. So long as you’ve built enough cash value, you can take out a policy loan without any questions asked.
Personal loans, on the other hand, don’t require security or collateral. However, that’s also the reason that personal loans are harder to qualify for. In fact, as many as three-quarters of personal loan applications get rejected.
No Credit Check Required
It’s your money, to begin with, so your insurer won’t have to pull out your credit report. Also, your policy loan won’t appear on your credit report.
Traditional loans and credit cards, on the other hand, require hard credit checks. These hard checks can have a negative impact on your credit score. What’s more, once issued, such loans and credit cards will show up on your credit report.
Lower Interest Rates
As of February 2020, two-year commercial bank personal loans had an average interest rate of 9.63%. Most insurance companies offer lower rates for their policyholders. Again, that has to do with policy loans being a secured type of loan.
No Required Repayment Schedule
Unlike other types of loans, you can pay back your policy loan on your own time. You can make a lump-sum payment for it, or you can coordinate monthly or yearly repayments. Whatever repayment schedule works for you, you can work it out with your insurer.
Potential Pitfalls of Borrowing Against Your Life Insurance Policy
As useful as policy loans are, they are still a loan, so you should pay them back. Otherwise, you risk having your beneficiaries’ payout reduced considerably. Your insurer will deduct whatever loan balance you fail to pay off from the death benefit.
Depending on how much you borrow from your policy, you also risk losing coverage if you don’t pay it back. The principal amount plus all the unpaid interest can go over your policy’s total cash value. If this happens, your policy could lapse.
Also, taking out a policy loan won’t help if you want to rebuild or increase your credit score. That’s because your insurer won’t report your loan repayments to the credit bureaus. As such, your good repayment behavior won’t have a positive impact on your credit report.
There’s also the matter of building up enough cash value to even borrow against it. Most insurers only allow policyholders to withdraw against their policy after ten years.
That’s why you should consider life insurance by the time you hit your 40s, or if possible, even earlier. The sooner you start a whole life insurance policy, the sooner you can build cash value. This, in turn, will then give you access to extra funds at an earlier point in your life.
When Should You Borrow From Your Life Policy?
So long as you have a dire need for funds, then you can take advantage of your cash value policy. By “dire,” we mean crucial financial situations, such as medical emergencies. The same goes if you need to settle your children’s tuition fees ASAP.
What’s important is to first explore all your financing options prior to taking out a policy loan. While life insurance loans often have lower interest rates, that’s not always the case. That’s why you should always compare and check your other loan offers first.
If your insurance provider offers the lowest interest rate, then that’s a good time to take out a policy loan.
Life Insurance Loans: A Good Alternative to Traditional Loans
Borrowing against life insurance policies could be a lower-cost alternative to personal loans. However, if you do decide to take out a policy loan, make sure that you can pay it back, even if it’s on your own time. The last thing you want, after all, is to use up too much of the death benefit.
Did all that pique your interest in purchasing a cash value life insurance policy? If so, then please feel free to request your whole life insurance quotes from us now!