What happens when a policyholder borrows against the cash value of his life insurance policy?
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Bankrate Logo Insurance DisclosureThis content is powered by HomeInsurance.com, a licensed insurance producer (NPN: 8781838) and a corporate affiliate of Bankrate.com. HomeInsurance.com LLC services are only available in states where it is licensed and insurance coverage through HomeInsurance.com may not be available in all states. All insurance products are governed by the terms in the applicable insurance policy, and all related decisions (such as approval for coverage, premiums, commissions and fees) and policy obligations are the sole responsibility of the underwriting insurer. The information on this site does not modify any insurance policy terms in any way. Life insurance policies are typically purchased to provide financial peace of mind to your family when you pass away. However, several types of life insurance policies have features beyond providing a death benefit. You may be able to borrow money from your insurance company using the cash value portion of your life policy as collateral. If you choose to take out a loan with your insurer, you may want to be sure that you understand how it works first. Bankrate examined some common situations where people borrow against their life insurance policy, but you’ll want to speak with a licensed agent at your insurance company to find out exactly how it works for your policy. Can you borrow from your life insurance policy?You can typically take out loans against permanent life insurance policies, but not term life insurance policies. Life insurance loans use cash value accounts as collateral. Term life insurance policies do not come with a cash value account, so policyholders can’t borrow money from their insurer against these policies. A term policy has only one financial consideration—the beneficiary’s death benefit if the insured person dies during the policy term. Permanent life insurance, such as whole life, is another story. With whole life insurance, a portion of your premium payment will go toward the death benefit, while another part will go into a cash value account that builds value over time. You may be able to take out a loan from your insurer and use your cash value account as collateral, but enough money will have to have accumulated in the cash value account first. For this reason, you may not be able to take out a loan against a new policy. In addition, if you fail to pay back interest on the loan, the amount you owe could be deducted from the death benefit if you’ve taken out enough money and not repaid it. Policy lapses are bad news if your family is still planning to rely on your life insurance policy. When you should borrow from your life insurance policyBorrowing money from a life insurance policy may be a better option than borrowing money from a bank for some policyholders. Potential benefits include:
Disadvantages of taking a loan out on life insuranceWhile there may be advantages to taking out life insurance loans, borrowing money from your life insurance policy also has some potential drawbacks. You may want to consider these potential cons before taking out life insurance loans:
How to borrow from your life insurance policyTaking a loan out on life insurance is fairly straightforward. The first step is to determine whether the life insurance policy is one of several types of permanent policies that are eligible for borrowing, including:
Unlike a bank loan, there is no approval process to earn a loan against a life insurance policy. It may also be possible to take the loan as a cash surrender value line of credit to be drawn from as needed. Interest on the loan will begin to accrue immediately at a rate determined by the insurer, which may be lower than the rate a bank would charge for a similar loan. Loan repayment could begin immediately and is usually broken up into monthly payments. Frequently asked questionsWhat is the best life insurance company?Since everyone has unique needs, there is no one-size-fits-all when it comes to life insurance. It’s usually a good idea to shop around and request multiple quotes from the best life insurance companies. Speaking with a licensed insurance agent may be able to help you determine the best company and policy for you. Is it worth it to have a permanent life insurance policy if I know I’m going to need a loan?Many insurance experts recommend considering term policies before whole life insurance policies, but it’s important to speak with a licensed insurance agent to determine what type of policy will work best for your individual needs. Term policies cannot be used for a loan, but these policy types are cheaper than permanent policies, which may help the insured save money and take a smaller loan from another source, such as a bank. How much does life insurance cost?The cost of life insurance depends on several personal characteristics, such as age and overall health. For this reason, the best way to find out how much you might pay for a life insurance policy is likely to talk with a licensed insurance agent or to generate quotes from multiple providers. Lizzie Nealon is an insurance contributor for Bankrate and enjoys making home, auto and life insurance digestible for readers so they can prepare for the future. Edited by Insurance Editor What happens if a loan taken out against the cash value of a life insurance policy is not repaid before the insured's death?If the loan isn't repaid before the insured person's death, the insurance company will reduce the face amount of the insurance policy by what is still owed when the death benefit is paid. In other words, if you're the policyholder, your beneficiaries get less when you die. So pay back those loans.
What happens to a life insurance policy when the policy loan exceeds the cash value?Eventually, the interest could also exceed the size of your cash value, which would cause your life insurance policy to lapse, triggering a possible taxable event on the earnings and denying your heirs a death benefit.
Can cash value be borrowed against a whole life policy?As cash value builds in a whole or universal life insurance policy, policyholders can borrow against the accumulated funds. Life insurance policy loans have one distinct advantage: The money goes to your bank account tax-free.
What happens when a policy is surrendered for its cash value?What happens when a policy is surrendered for cash value? When a policy is surrendered, you'll lose coverage and no longer be responsible for paying insurance premiums. If your policy has cash value, you'll get this money after surrender fees have been taken into account.
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