Pros and Cons of borrowing against a life insurance policy

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By: tiarajoseph11
on 21st Jan,2016

Let us find out the pros and cons of taking a loan against your life insurance.

Like any other conventional loan, a loan borrowed from life insurance policy also has some pros and cons. It’s good to check out both aspects before choosing whether or not to borrow against your whole life insurance policy.

How a loan from a life insurance policy works

Unlike an agency-backed, conventional bank loan, which usually need a lengthy application process and a full credit check, there are no obstacles you have to cross to borrow from your life insurance policy,. In fact, you can take the loan up to the amount of cash value you’ve already accumulated. The policy will be served as a collateral of your loan.

Terms of repaying a life insurance loan are very flexible mostly, but it solely depends on your insurer. You may not have to pay the loan at all. After your death, the outstanding balance will be deducted from the policy’s monetary benefits. As long as you don’t extend the policy too much and gain negative equity, you can continue borrowing out new loans for as long as you’re paying the premiums.

The pros of borrowing against life insurance

  1. It is an easy and relatively fast process. You don’t need any QUALIFICATION verification, even you don’t need to fill out any application. You just require the credit and income checked. Don’t be afraid of any high fees and taxes. The loan will be approved in 5-10 business days for most companies, and in some cases they provide quicker options.
  2. The loan itself is flexible. You can borrow nearly 95% of the cash value of your whole life policy. When you take out the loan against your own insurance policy, you can plan your repayment schedule, modify it, or even carry on without repaying it if you have such issues. On the other hand, most non-insurance, conventional loans have strict repayment rules that may not work for you at all.
  3. The loan is cheaper than other conventional loans. Life insurance policy loans have interest rates between 4% to 8% range. But, that’s not equal to a rate of the conventional loan for the same amount. Actually, loans against your life insurance policy are considered as borrowing against an account that has an internal rate of return and a cash value. The cash value is continuously growing as a dividend. The generated money offsets the interest on the policy loan.
  4. Taking life insurance loan is not a taxable event. Although there are some exceptions. The IRS will never have that information about your borrowed money. A life insurance policy loan isn’t considered as “income” in most situations.

Read more: Points you must know more about Life Insurance to get the best coverage

The cons of borrowing against life insurance

  1. One disadvantage you will always have when taking the loan from a life insurance policy. That is, life insurance policy is considered to be an asset, which you are using to get a new asset. So, you always need to evaluate whether or not this loan is actually needed, or whether you can save enough by reducing your expenses and avoid borrowing the loan in the first place.
  2. Always have a chat with your policy advisor before borrowing against your life insurance policy. You need to understand the effect that taking the loan against your policy will have! Don’t think that just because you have a “permanent life insurance” that you should borrow against it. The Universal Life and Equity Indexed Universal Life (EIUL) have set very different terms than a normal whole life insurance. So, don’t forget to ask your policy agent such terms prior to applying for the loan.
  3. You are taking the loan against your policy’s cash value and suppose you are not willing to pay it back. As a result, the unpaid life insurance loan (and its interest) will reduce the total benefits, which the beneficiaries are entitled to get. You’ll also have a solution for this problem. It’s called Paid-Up Additions, or PUA’s. You need to begin the payment of the loan along with a PUA. PUA’s increase the cash value of the policy amount for future usage and also securing the benefits for the heirs. Approximately 95% of the payment value increases cash value, and about 5% goes to increase the death benefits.
  4. Your unpaid loan balances might cause a tax penalty if you borrow the loan more than you’ve saved earlier and if you decide to surrender your policy later. There are some “cash-rich” insurance policies, which have been designated by the IRS through “modified endowment contracts”. Taking out a loan against MECs is not tax-free. If you have any confusion that your contract might be an MEC, make sure to have a talk about the possible tax consequences before you borrow.
  5. Cash value of your policy is the emergency fund for your life. If you borrow a high portion of your policy’s cash value and don’t pay the premiums on time, your policy may lapse, and the death benefits that your heirs or beneficiaries will be getting are also going to lapse.

Don’t miss out: What are the reasons for having a life Insurance even after you retire?

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