How to Borrow Against Your Life Insurance

Life insurance policies give your loved ones financial security in the event of your death. But what if you could use the assets in a policy before you die? You may be able to access the cash value component of your coverage by borrowing from the policy – provided you have the permanent, rather than term, type of life insurance.

Such loans from your life insurance are typically less costly than a personal loan, and have more flexibility when it comes to repayment. Still, you should be aware of the risks before proceeding with a life insurance loan.

In this guide, we cover the ins and outs of how to borrow against your life insurance. Read on to find step-by-step instructions for how to take a loan from life insurance, along with more on the potential pitfalls of doing so.

Can you borrow from your life insurance?

Your ability to borrow against the value of your life insurance policy will depend on the type of policy you have and your provider’s rules for life insurance loans.

If you have a term policy, it’s unlikely you'll be able to take a loan from your life insurance. Term insurance lacks a cash value component, and without that your policy doesn’t provide the collateral a life insurance company requires before allowing a loan from it.

Permanent life insurance policies, on the other hand, do have a cash value. This category of coverage includes whole life insurance and universal life insurance, among others. After you hold the policy for a few years, the cash value of your permanent life insurance will often rise as it accrues interest or grows through investment. (That said, it might be five years or more before the value becomes substantial enough to cover a major loan.)

If you need to tap into these savings, you'll likely be able to do so by using them as collateral for a loan from your life insurance company. The rules around life insurance loans can vary based on your provider and policy.

How does borrowing from life insurance work?

Provided your insurance company allows you to borrow against the value of your life insurance policy, the loan process is typically fairly straightforward. You fill out paperwork to request a loan and review the terms of the lending agreement. The funds should be available in your account in a matter of days.

It’s important, though, to exercise due diligence before you sign for the loan. You’re likely to be charged interest, so check the rate – and compare it to what you might have to pay for a traditional loan, to be sure the loan makes financial sense.

Check, too, on the consequences should you fall behind on that schedule of payments. While you can set your own repayment schedule, the policy could decrease in value or even be voided entirely if you don’t repay enough that the remaining cash value in the account stays above the loan amount and its accrued interest.

Voiding the loan could not only deprive you of the policy's proceeds but spell trouble with your taxes. If you take out a life insurance loan, neglect to pay it back and then have your policy voided as a result, the IRS may tax the proceeds you receive. It’s worth reaching out to a tax professional before proceeding to verify your potential tax liability if you’re worried about your ability to pay the loan back.

How soon can you borrow against a life insurance policy?

If you can borrow against your life insurance, that option typically kicks in as soon as you accumulate enough cash value in the policy to serve as collateral for a loan. That accrual does not begin immediately, however. Permanent life insurance policies generally begin accruing cash value a year or more after they are activated.

The mechanism through which life insurance policies accrue cash is sending a portion of your premium payments to a cash value account. A greater proportion of premiums is sent to the cash account in the early years of the policy, especially if you are relatively young – and so less likely to die and trigger a death benefit payment, statistically speaking. You may be able to increase the rate at which your policy accumulates its cash value by purchasing an optional paid-up rider.

How to borrow against life insurance

If you’ve decided to at least consider taking out a loan from your life insurance policy, here’s the step-by-step process you should follow.

1. Contact your life insurance company about your loan eligibility

To begin, make sure that your current life insurance policy is eligible to serve as collateral for a loan from your provider. Rules around this can vary, but it’s often as simple as making sure that you have sufficient cash value accrued that a loan is permitted.

The best way to do this is to contact your life insurance company directly. Speak with a representative to learn whether your policy qualifies for loans or if there are cash value or policy timeline milestones you still need to meet before becoming eligible.

2. Determine how much you can borrow

When you contact your provider to see if you qualify for a life insurance loan, check also on how much you might be able to borrow at the moment. Many insurers allow you to borrow up to 90% of the cash value of your life insurance policy. With such a policy, if you have $10,000 in cash value, you would be able to borrow up to $9,000 as a loan.

3. Weigh the pros and cons of borrowing against life insurance

Now that you know how much you can borrow against your life insurance benefit, it’s time to assess how much you should take out from the policy. To aid in that decision process, consider these pros and cons of life insurance loans.

PROS

You can make payments on your own time frame. Unlike a traditional loan, with its monthly payment schedule, you can repay a loan from your life insurance at your own pace. (However, there are risks of repaying too slowly, if you borrow a lot from the policy. See Cons below.)

Relatively low interest rates. Life insurance loans typically have lower interest rates than standard bank loans.

A certain credit score is not required. Because you use the cash value in your policy as collateral on the loan, the insurance company does not need to check your credit score before approving the loan.

CONS

Tax implications if you don't repay. You can be taxed on the loan if you fail to pay it back.

Loss of death benefit. A key risk with borrowing from your life insurance policy comes if you fail to pay it back quickly enough. As interest accrues, your loan balance could eventually surpass the total cash value of your life insurance policy. If that happens, your policy may be voided or your life insurance death benefit could be reduced in order to cover the interest payments.

4. Evaluate interest rates and loan terms

Before you proceed with a life insurance loan, make sure the loan interest rate and terms set by your provider work for you. In short, review the terms of the agreement and make sure you read the fine print for the loan’s terms and obligations. If you don’t understand some of the loan language or are still struggling to make a decision, ask a financial advisor for help.

5. Complete a policy loan application

Next up is to complete a policy loan application. This may be as simple as telling your provider which life insurance policy you want to use as collateral for the loan and providing some information about where you would like the funds to be deposited.

6. Wait for approval and receive funding

At this point, you must wait for the approval process to conclude, and for the funds to be deposited into your account. The timeline for this can vary by provider. But be prepared for a wait of up to a month for the approval to be made and the cash payout to be completed.

7. Make timely loan repayments

Once you have your funds, give some thought to how and when you will repay the loan. Setting a repayment schedule you can stick with can help you avoid the dangers of life insurance policy loans. Even if you can only start with interest payments, that’s better than putting repayment off entirely and allowing the interest to accumulate – which will potentially endanger your benefits if the interest balance grows too large.

Can you borrow against term life insurance?

In a word, no. Term life insurance policies don’t carry a cash value, so there’s no collateral against which you can borrow.

What type of life insurance can you borrow from?

Life insurance you can borrow from must be of a type known as permanent. Unlike term life insurance, permanent policies have a cash value against which you can borrow. These policies come in different varieties, including:

• Non-participating whole life. These policies carry the same premium and benefits throughout the duration of your life, but they pay no dividends.

• Participating whole life. This life insurance option pays dividends, which can increase the cash value of your policy over time.

• Universal life. With this type of permanent life insurance, you get a minimum interest rate guarantee, but the rate at which your cash value grows can go up or down over time based on a variety of factors.

• Variable life. The cash value for this type of life insurance can go up or down based on investment results. As with any investment portfolio, you get to allocate your cash value in various investment pools, such as stocks, bonds and mutual funds.

If you’re in the market for a policy, whether to borrow from or not, our guide to the best life insurance identifies recommended providers of all kinds.

How much can I borrow from my life insurance policy?

Life insurance companies typically allow you to borrow up to a maximum percentage of the total cash value of your policy. The figure is often around 90%, but it might be higher or lower depending on your provider.

Keep in mind, however, that just because you can borrow up to 90% of your life insurance policy doesn’t mean you should. Overborrowing can put you at risk of reducing your benefit values or voiding your account.

What happens if you don't pay back a life insurance loan?

Life insurance companies often won’t set deadlines you need to meet when paying back a loan. But that’s arguably a mixed blessing, since it can make it all too easy to ignore the need to make repayment.

If you don’t make any payments toward your outstanding loan balance, the insurance company will eventually start tapping some of the cash value of your account to cover interest costs. This can lead to a situation where you owe more than you have borrowed. If and when that happens, your provider could void your policy.

For more detailed guidance, review your provider’s policies toward non-payment. You should be able to find these in your lending contract.

Summary of Money's advice on how to borrow against life insurance

Using the cash value of your life insurance policy as collateral for a loan can be an affordable way to borrow money. Indeed, your life insurance policy can be a less costly way to borrow than alternatives such as putting a major expense on a credit card or taking out a personal loan.

However, not all life insurance policies allow loans; the policy must be of the permanent type, which accumulates a cash value against which you can borrow. Also, be aware of the risks to using this borrowing source. Failure to repay your loan could eventually lead to the reduction of your benefits, or even the outright cancellation of your policy.

To learn more about the different types of life insurance and how they work, consult our guide to life insurance for beginners.