How To Borrow From Your Life Insurance the Right Way

Life insurance is meant to provide money to your dependents when you die and are no longer there to support the household financially. The payment to the family upon your passing is the death benefit. Some life insurance policies even offer living benefits, in that you can borrow from the plan when you’re still alive. Here's how to do that.

The common types of life insurance are term life insurance, whole life insurance, and universal life insurance. Loans aren’t available on term life insurance, just whole life and universal life insurance policies. These offer an investment component called cash value.

If you have a life insurance policy with cash value, the premium you pay is split and put in different accounts. A portion of the premium goes to funding the death benefit account, and the other portion goes to funding the cash value component of the policy.

The cash value side operates as an investment account that earns you dividends. You can borrow from the insurance company, with the funds in the cash value account acting as collateral for the loan. To borrow, you only need to complete a form. If you've sufficient cash value, the loan will be granted. You’re expected to repay the loan with interest. The interest rate may vary across insurance companies, and it can be fixed or variable.

You may be able to borrow up to 90 percent of your policy’s cash value. However, it may take several years before you can access a life insurance policy loan. It takes time to build cash value, and you need to have enough money in the account to cover the amount you wish to borrow.

Taking a loan against your life insurance policy can be a quick and easy method to raise money to cover medical bills, settle home improvement costs, pay college fees for your child, or even pay for vacation expenses. The insurance company won’t ask what you intend to do with the loan.

A major advantage of borrowing from a life insurance plan is that the interest rate is typically lower than what you’ll be charged on a bank loan or credit card. Moreover, there's no mandatory monthly payment, making the payback schedule flexible. Additionally, life insurance loans won’t show up on your credit report, so they don’t hurt your credit score.

Whereas taking a life insurance loan may be easier and cheaper than borrowing from the bank, you should think twice about it. If you pass before fully repaying the loan, the outstanding loan and interest would be subtracted from your policy’s payout value. As a result, your family would receive fewer death benefits. Another risk is that the policy may lapse if the outstanding loan and interest exceed the cash value, resulting in a higher tax bill for you.