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Many people buy life insurance to provide money for their families to use when there’s a loss of income after death. Certain types of life insurance also offer the ability to take a loan against the policy.
Life insurance policy loans have major advantages over bank loans or credit cards, but they are still loans — and if you don’t pay them back, there are consequences.
What is cash value life insurance?
Unlike term life insurance, which pays out only if you die during the policy term, permanent life insurance policies — sometimes called cash value life insurance — pay out no matter when you die. Part of your premium goes into a separate account that builds up cash value.
When there’s enough cash value, you can use it to:
Buy more coverage to boost the death benefit
Withdraw cash. (If you don’t repay the money, the death benefit is reduced.)
Borrow money from the life insurance company. The cash value is used as collateral.
Getting cash, no questions asked
Whether you need money to pay a medical bill or your kid’s college tuition, a loan against life insurance cash value has some advantages over credit cards or personal loans.
Advantages of a life insurance policy loan
No credit check
Low interest rates
Life insurance policy loans likely have lower interest rates than bank loans or credit cards. According to the latest data from the Federal Reserve:
No timetable for repayment
Any method of getting quick cash has drawbacks, and life insurance loans are no exception.
Disadvantages of a life insurance policy loan
May not be available
It can take many years to build up any significant cash value in a permanent life insurance policy. In the early years of the policy, there may be little value, if any, to borrow against.
Risk of reduced payout
The death benefit will be reduced If you don’t repay the loan during your lifetime.
Risk of losing coverage
Possible tax consequences
You could owe tax on some of the money you haven’t paid back if your policy lapses before the loan is fully repaid.
Should you borrow from cash value life insurance?
A loan against life insurance could be a good alternative to running up a credit card balance or paying exorbitant interest on a personal loan.
Approach any loan from your life insurance company carefully:
Keep an eye on the accrued interest.
Set your own schedule for repaying the loan.
Stick to the plan to repay the loan in full if your family will need the full death benefit.