Life insurance policy loans can be a convenient method to access funds in an emergency, but there are a few things to remember before applying for one. First and foremost, you can only borrow against whole life insurance or a universal life insurance policy.
Term life insurance, often a more affordable and practical choice, does not accumulate value. It has a finite lifespan of one to thirty years at most. However, there are situations where a term life policy can be changed to a permanent one with cash value accumulation.
How and When to Take a Life Insurance Loan
Borrowing against the cash value of a whole or universal life insurance policy becomes an option once the policy matures. Unless your policy expires before the loan is repaid, the funds from a loan against a life insurance policy will be deposited into your bank account tax-free.
The policy's cash value will grow faster or more depending on various circumstances. There is yet to be a set timeframe for when a policy can be pledged as collateral for a loan. After two to five years, the cash value of many plans begins to grow and when is it safe to borrow against your life insurance policy.
No Obligation to Pay Anything Back
The lack of need to repay loans taken out against your cash worth is appealing. However, there are consequences for not doing so.
You can return the loan in whole or in part by making interest-only payments once a year, making interest-only payments every year, or taking interest out of the cash value at any time.
"Interest rates on loans are like interest rates on any other kind of loan," Reich explains. Depending on the terms of your policy, interest rates may be set at a fixed rate or allowed to fluctuate. 3
When Obtaining A Loan Is A Good Idea
There are instances where taking out a loan against your life insurance policy might be a good idea. Those things are:
Need Money Now or Can't Get a Loan
Life insurance policies may be a quick and easy way to get cash for things like a new furnace, medical bills, or other unexpected needs because the Money is already there. Because of the collateral nature of your cash worth, no credit check is necessary.
You Can't Pay Your Policy's Annual Premium
Never let your life insurance coverage lapse due to the inability to pay premiums. The policy will remain in force if the loan amount exceeds the insured's death benefit.
Your Alternative Loan Options Carry Exorbitant Interest Rates
Bernstein argues that life insurance policy loans are a viable alternative to more conventional forms of credit. The interest rate on other types of loans, such as personal loans, is often greater.
They may also ask for additional security in the case of home equity loans. No loan terms are associated with a life insurance loan, such as a due date for repayment, a grace period during which interest is waived, or any additional expenses.
Drawbacks of A Borrowing Against Life Insurance
Taking out a loan using your life insurance as collateral has drawbacks. However, there are usually restrictions on taking out loans against cash value policies. You'll have to pay the interest that builds up on the loan.
Although the funds in the policy technically belong to you, policy loans are not interest-free. The death benefit will diminish if the loan is not repaid, and the policy will be void if the loan balance exceeds the insurance's cash value.
The Internal Revenue Service (IRS) may classify the Money you withdrew as income if the policy expires. 6 Term insurance loans often do not have a payback deadline, unlike other loans.
When Is The Time To Take The Money Out of Your Whole Life Policy?
You shouldn't cash in your life insurance policy if you want to leave the proceeds to your spouse, children, or other beneficiaries. You may be tempted to cash out or surrender your policy if you are short on cash and need Money for major medical costs or a financial emergency.
The premiums you've put into the policy, plus any interest, will be returned to you. However, you can also keep some of the Money in the policy after taking a loan or withdrawing and restoring the entire death benefit when you repay the loan.
Summary
Many people can benefit financially from purchasing a life insurance policy, but this is only the case for some. Your unique financial circumstances will determine if and what life insurance coverage is appropriate for you. Similarly, if you have a cash-value insurance policy, it's important to consider the benefits and drawbacks of each option before selecting which is best for you financially.
