Can you borrow money from your life insurance policy?

Life Insurance 101

Many people have no idea how life insurance actually works. So, let’s first go over that, because you need to understand that before you can understand how borrowing against a policy works.

In the simplest terms, all insurance products work a little bit like the casinos in Las Vegas, because, in some sense, it is a form of betting.

For life insurance, they are basically betting that you will live long enough to pay them enough for it to make sense to pay you the face value of the policy when you do finally leave this world.

Smart math people need to crunch the numbers to determine what to charge and what to pay out and have it all come out right in the end.

In the insurance industry, these people are called actuaries and they are a critical part of the industry.

Keep reading to learn more about borrowing against your policy and make sure your try our free life insurance comparison tool above!

–The Business Side of Things

In other words, the premiums charged for a policy are determined by complicated number crunching.

The many small amounts of money that come in the premiums need cover both the payouts promised and the overhead, even though the payouts can sometimes be large and may come in at random times.

Overhead is the cost of doing business. Whether it is a betting establishment in Las Vegas or a perfectly respectable insurance company, you have to pay employees and cover the cost of a building and other expenses in order to have a business at all.

Many people probably already understand those general aspects of the business.

However, most consumers seem to have no real awareness of another piece of this equation: The fact that the insurance company takes your premiums and invests them.

–Insurance as a Social Good

These investments are part of what makes insurance make sense as a social good.

You may have learned in middle school that insurance is supposed to serve a social purpose of helping to protect all individuals against risks in order to keep society as a whole more functional.

When something bad happens to one individual and they can’t cover the cost, their life or the lives of their loved ones can come unraveled.

If their lives come unraveled, then society as a whole becomes less stable. It can be the start of a downward spiral.

Insurance can help prevent that from happening by pooling the resources of many people to protect against sudden, unexpected costs.

When individuals and their families can get the resources they need in times of personal trouble, all of society is more stable.

But this process of pooling resources to protect individuals financially only makes sense if those resources are invested. This helps build up more of a buffer against economic disaster.

–Insurance as a Financial Product

So, in some sense, an insurance company is a kind of financial services company that pools the money of many people and then invests it.

This is not terribly different from other financial services, such as retirement funds. The basic premise here is that investment experts will have a better track record than a random individual trying to go it alone.

Thus, with whole life, you can sort of think of the policy as being kind of like an investment account.

When you purchase a whole life policy, the idea is that you will keep paying them, and they will invest your money until you have accumulated some lump sum associated with the policy.

This is how you end up with a cash value amount. It takes time to accumulate because first, you need to cover some of the overhead involved in issuing a policy.

But, at some point, if you keep a whole life policy long enough, it will have a cash value amount.

This cash value amount is the amount of money you would get back if you canceled the policy.

It is also the reason you can borrow from your whole life policy: You are borrowing against the cash value amount.

It is also the reason you can borrow from your whole life policy: You are borrowing against the cash value amount.

To be perfectly clear here, term life insurance policies never have a cash value amount. So you are not going to ever find yourself borrowing from a term life insurance policy. That is simply not an option.

Why borrow from your life insurance?

If you find that you need to borrow from your life insurance policy, you aren’t borrowing from anyone but yourself.

It’s your money and you don’t have to explain how you are planning on using it in order to borrow it.

So, again, if your life insurance has a cash value, this is your money. As an analogy, it is like money in a savings account.

–How It’s Like Money in Savings

You wouldn’t need to explain, much less justify, to a banker why you wanted to take some money out of savings. You wouldn’t need to go through an approval process and get someone’s permission.

If you took money out of savings, no one would run a credit check. Also, no one would send any information to the credit bureaus that track whether or not you are a good credit risk.

Also, like with taking money out of a savings account, you can spend it however you choose. This is not true for many other kinds of loans, such as a mortgage.

A mortgage is approved for the purchase of a specific piece of real estate. You can’t just do whatever you want with the money. Loans are often conditional upon what you plan to do with the money. This loan is not.

Loans are often conditional upon what you plan to do with the money. This loan is not.

So, when you borrow from a life insurance policy that has a cash value, many of the usual restrictions or concerns with borrowing simply do not apply. This is part of why people do it.

–But It’s Still a Loan

Of course, it isn’t actually money in a savings account. That was just an analogy. It is, in fact, a loan.

Because it actually is a loan, not a withdrawal from a savings account, you will be charged interest on the amount you borrow.

But, the interest rates you pay on this kind of loan tend to be much lower than you would get charged on other kinds of loans.

The low-interest rates are another reason people sometimes borrow from their life insurance policy. Low-interest rates make it a more affordable form of credit.

In addition, there is no mandatory monthly payment on this kind of loan. This can have a big appeal for someone who makes plenty of money, but their income is erratic. Unfortunately, it can also be appealing to someone who is in serious financial trouble.

Unfortunately, it can also be appealing to someone who is in serious financial trouble.

In addition to the lack of regular payments, the reason this loan does not affect your credit score is because you can’t really default on it. The insurance company is not going to lose money if something goes wrong here.

The insurance company is not going to lose money if something goes wrong here.

So if you are in serious financial trouble and can’t pay it back, the insurance company has built in protection. How that piece gets handled brings us to this next section.

But There Are Potential Downsides

That all sounds really good — and it is! By now, you may be feeling like that sounds too good to be true and wondering “So, what’s the catch here?” So, let’s talk about the potential downsides.

So, let’s talk about the potential downsides.

Although there are several potential problems with doing this, these are the two biggest concerns for most people.

First, it can lead the policy lapsing or terminating. Second, if you die before this loan is repaid, it will be deducted from the face value of the policy.

Second, if you die before this loan is repaid, it will be deducted from the face value of the policy.

If you get into serious trouble and cannot pay the loan back, that can cause the policy to terminate.

Alternately, if you aren’t making payments and the accumulating interest owed pushes you over the cash value amount, the policy can lapse.

This is why borrowing from your insurance does not impact your credit rating.

They just cancel the policy and tell you that you have gotten all the money you are going to get out of it.

They treat it kind of like you voluntarily surrendered the policy for its cash value.

But, if the policy lapses or terminates, the amount you borrowed may be classified by the IRS as taxable income.

This can be a big problem if the amount borrowed is substantial. You may suddenly have a big tax bill that you have no means to pay back.

It also means you no longer have that life insurance policy. So think about the reasons you took it out. Do they still apply? Do you still want life insurance coverage? Then you don’t want your policy to terminate.

How to Borrow

The process of borrowing may seem intimidating. So, let’s go over that here.

First, you need to be the policy owner. Make sure you are listed as the owner of the policy. Consult your policy to see if you listed as the owner

Then call the company or check their website. They may need to send you forms to fill out.

But, these days, some companies provide access to those forms on their website or provide for the ability to do the loan by phone.

Determine how you wish it to be paid. One of the best reasons to borrow against the cash value of the policy is to cover the premiums when you can’t afford them for some reason.

Unsurprisingly, this is one of the ways the loan can be distributed: As a payment of premiums.

So, once you have considered tax implications and other issues, the actual loan process shouldn’t be too bad. Remember: There is no approval process.

Getting the money is a matter of filling out the right forms, just like you need to fill out a withdrawal slip for a savings account.

So even though there is some paperwork to do, no one is deciding if you are allowed to have this money or not.

Make Sure You Keep Track

Because there is no set repayment plan, you will need to keep track of this loan.

Keeping track of how much you owe, how much interest is accumulating and other details will help prevent you from accidentally causing the policy to terminate.

Yes, it is your money and you can do whatever you want with it. Another way of putting it is, that power and responsibility go hand in hand. The responsibility of tracking this loan is also yours.

You have tremendous freedom to borrow from your life insurance without answering to anyone over it.

The flip side of that is that they also aren’t keeping close track of whether or not you are making payments to them and they aren’t going to send you reminders.

They do have records and will notify you if your policy terminates over this loan. But they aren’t going to send monthly loan statements.

So you should create a tracking mechanism. Not doing so will put you at risk of terminating the policy, which can have tax consequences.

Plus, if it terminates, you won’t have life insurance anymore. If you didn’t have need of the policy, you probably wouldn’t have taken it out. The reasons you took it out probably still apply.

Don’t forget to use our free insurance comparison quote tool below to compare insurance rates today!