Most of us have found ourselves in a financial jam at some point in our lives.
If you’re looking for a loan, consider looking at your life insurance policy. You may be able to borrow money from your insurer. The great news is that the process is simple. The repayments are flexible, and it’s usually cheaper than borrowing from a bank.
Here’s how it works.
What is cash value life insurance?
Cash-value life insurance is a form of whole life insurance. When you pay premiums to the insurer, they put a portion into a cash-value account. You can access the account. The money in the cash-value account is invested, so it usually grows over time. If you choose to cancel your coverage, your insurer will pay you the cash value minus some termination fees.
How Borrowing from a Life Insurance Policy Works
You can borrow some of the cash value of your policy. However, it’s important to note that the cash value usually accumulates slowly. You may not be able to borrow much in the first few years. You will also owe interest on the amount you borrow.
Do You Have to Repay the Loan?
Unlike a regular loan, there are no forced repayments. The interest you owe just keeps accruing. If you never pay back the loan or the interest, then the insurer will either reduce the amount of your coverage or take the money out of the benefit paid to your dependents.
Loans and withdrawals on life insurance are treated very differently for tax purposes. If you don’t repay your loan, they treat it as a withdrawal. If so, you could end up paying extra tax.
Why Borrow from a Life Insurance Policy vs. the Bank?
There are a lot of reasons to choose a life insurance loan over a bank loan. Here are a few of them:
Access
When you borrow from an insurer, your life insurance policy is used as collateral. Essentially, there are fewer credit checks and hoops to jump through.
Credit impact
Life insurance loans don’t appear on credit checks, so they won’t affect your credit score the way a bank loan can.
Flexibility
You have the flexibility of choosing your repayment schedule with a life insurance loan. Conversely, a bank will insist on regular repayments.
Lower interest rates
Unlike a life insurance loan, credit cards and personal loans don’t require collateral. This means they usually have higher interest rates.
Top tip
Because insurance policies are taxed differently than bank loans, speak to your accountant about which method is best for you.
Before You Borrow
Loans against insurance policies can be complex and need to be carefully managed. If you don’t repay your interest, your debt will grow too large, and your policy can be cancelled.
It’s critical to speak to a financial advisor or your life insurance agent before you borrow from your insurer. Your advisor can run an “in-force illustration” for you. This will tell you how much the loan will cost you if there are hidden fees, and what the long-term impact will be on your insurance coverage.
Conclusion
Combining life insurance and lending can get complicated. But if you do your homework, get good advice, and keep an eye on your balance, life insurance loans offer a great alternative to standard bank loans.
