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We all know that life insurance has originally emerged to offer many benefits for the beneficiary’s right after the insured’s death. However, this is no longer the only service that life insurance policies provide.

Life insurance policies have now incorporated a kind of investment/savings component wherein you can get several benefits other than insuring the beneficiaries.

Some people exploit these benefits, especially the ability to borrow cash from the policy’s cash value after paying premiums for a pre-determined period of time.

It’s worth mentioning that the life insurance policies that provide such a type of service are whole life insurance and universal life insurance policies.

How Does Borrowing Against a Life Insurance Policy Work?

One of the best advantages of life insurance policy loans is that you aren’t supposed to pay the loan back. Bear in mind that a loan from your insurer is easier to get than the loan from a bank since your insurer uses your policy’s cash value as collateral.

In case you don’t pay back the loan, it is fine; the life insurance company will deduce it when it’s time for the death benefit to be paid out.

One problem with this is that if you don’t pay back the loan, the interest will compound and accordingly be added to your loan balance. Over time, the interest can pile and exceed the cash value of your policy. That’s why experts recommend controlling your loan balance because otherwise, you’ll lose your policy.

Things to Consider Before Borrowing

There are many things you should take into consideration before borrowing against your life insurance policy.

  • Discuss with your insurance advisor how the loan is going to affect your life insurance policy, and most importantly ensure that the death benefit won’t be threatened.
  • Make sure that the interest resulting from the loan is affordable, so you don’t lose your policy in the long run.
  • In case you think of depending on your policy’s dividends to pay your loan interests, consult your insurance advisor first. This can be expensive if it isn’t planned well and can accordingly make you lose your policy.

What Advantages Does This Service Have?

  • No fees. One of the prominent pros of insurance policy loans is that there are no fees. Since your cash value is your own money, you can borrow from it with zero fees.
  • Low-interest rates. Although the life insurance company charges loan interests, the rates if these interests are often very low. Let’s take the following example. Interest rates on borrowing from a cash value range from 4% to 8% that if you take out a loan of $25,000 against your cash value, the interest you’ll need to pay would be at least $1,000.
  • Easily accessed. Since your life insurance company utilizes your account as collateral for loans, there would be no tedious, long application processes for taking out the loan. All you need in order to take out a loan is having enough money in your account. It’s worth noting that the loan can often be in your pocket in a week.
  • No tax. According to the IRS, the loan against your cash value is tax-free because the funds you get aren’t considered as income.

What Drawbacks Does This Service Have?

  • Death benefit reduction. In fact, this isn’t the main drawback because several life insurance policies are created for the purpose of increasing the death benefit in the long run. However, if you take a loan out, the death benefit that remains can still offer good coverage.
  • Those loans aren’t interest-free. As mentioned before, if you don’t pay back the loan, the interest will absolutely decrease your cash value.
  • Tax consequences. If you borrow more than what you’ve invested in your policy, a ‘tax event’ can take place in case you cancel your life insurance policy. The ‘tax even’ can take place if the loan amount is greater than the amount deposited in your policy.

Borrowing Against Cash Value vs. The Bank

Take it as a general rule: borrowing from your cash value has many benefits compared to borrowing from a bank.

  1. Some people purchase cash value life insurance policies only to build cash so that they can borrow from them later in life.
  2. Some people borrow against their cash value in order to avoid the lengthy loan applications that the bank requires.
  3. Borrowing against your cash value can help you avoid the loan hassle that you might face when borrowing from a bank. If you intend to repay the loan on time, borrowing from your cash value is great for you.
  4. Borrowing against your cash value is more flexible in terms of repaying. For instance, when you borrow from a bank, you need to make monthly payments over a fixed term. On the other hand, when borrowing against your cash value, you can pay as much as you can at any time.
  5. Finally, if the loan you’re taking out is less than your cash value and you intend to pay it back, then you’re recommended to borrow against your cash value.

Are There Any Alternatives?

If you are not okay with the idea of risking your life insurance policy, don’t worry; there are many other options wherein you can get a short-term loan.

A home equity loan is good, especially for homeowners. Such a loan often has an affordable interest rate. The lender will take your credit history into account before accepting your application.

Conclusion

Whereas there are many factors you should take into account before borrowing from your life insurance cash value, you should remember that the benefits you will get when taking such a kind of loan outnumber the ones you will get when borrowing from a traditional lender (a bank).

Experts recommend conducting your own online research in order to understand the process before you proceed any further with the loan.