Borrowing Against Life Insurance: What to Know Before You Do It

About 60 percent of people in the United States have some form of life insurance.

Are you one of them? If yes, you’ve already made one important financial decision. With this policy, the financial future of your dependents is secure, especially when you won’t be there to provider for them. Upon your death, your life insurance provider will pay out your death benefits to your beneficiaries.

Life insurance can also be helpful to you when you’re alive. Did you know you can borrow against it?

Continue reading to learn more about borrowing against life insurance.

The Type of Life Insurance Policy Matters

There are several types of life insurance policies. However, the most common are term life insurance, whole life insurance, and permanent life insurance.

The type of policy you have will determine whether you can borrow against it.

To be able to borrow against a life insurance policy, it must have a cash value option. This is a savings component that allows policyholders to save money as they keep making their premium payments. A portion of your premiums goes toward maintaining the life insurance coverage, while the rest goes into the “cash value” account.

Over several years, you’ll have saved up a pretty penny, against which you can borrow.

Now, if you hold a term life insurance policy, then you cannot borrow against your policy. Time life policies don’t have a cash value component. But if your policy is whole or permanent, you can go ahead and borrow.

The Policy Is Simply Collateral

When you’re taking out a policy loan, you might feel like you’re borrowing your own money. After all, the cash value of the policy represents your savings.

Well, theoretically that’s true, but you aren’t borrowing from your life insurance, you’re borrowing against it. Your life insurance company will give you the policy loan (if you qualify) and use the policy benefits as collateral. If you default on the loan, the company can recoup its losses from your benefits.

There Are No Credit Checks

Do you have bad or poor credit? You’re probably wondering whether your credit will influence the insurance company’s decision-making.

The good news is when you’re borrowing against your life insurance, no one will bother to check your credit. A policy is essentially a secured loan. And like all secured loans, lenders know very well that they can always repossess the collateral and recoup their money in the event that a borrower defaults on it.

No Tax Repercussions

A policy loan isn’t a form of income. It’s a loan like any other, which you’ll repay with interest. As such, the taxman won’t take a piece of the money.

Similarly, the insurance company won’t ask how you intend to use the policy loan. You have the freedom to spend it however you please.

That being said, taking out a policy loan is a big financial decision. You want to use the money wisely. Keep your ears tuned to the perpetual wealth podcast to learn how to best use your life insurance loan.

Borrowing Against Life Insurance Is a Sound Move

Borrowing against life insurance is a good move. You pay higher premiums to maintain a policy with a cash value component, so you shouldn’t shy away from borrowing against your policy when the right time comes.

Keep tabs on our blog for more tips on personal finance.