Dear Toddy,
My wife has finally agreed to us buying a side-by-side, but we’d have to take out a loan. I was talking to my brother, and he said something about borrowing against my life insurance policy instead of getting a loan from the bank. I have an indexed universal life policy – is this something I can do? And if so, how?
Thanks, SxS Dreamer
Dear SxS Dreamer: While borrowing against life insurance is possible, not everyone is able to do so based on the type of life insurance they carry. Thankfully, you have a universal life policy, so you’re in luck!
While you can borrow against your indexed universal life policy, there are some things to consider when deciding whether borrowing against your life insurance is the right move for you.
How to Borrow from Life Insurance
Taking out a loan against your life insurance works differently than other types of loans (think car, home, HELOC, etc.). While most people know how credit cards, mortgages, and car loans work, many aren’t familiar with how to borrow from life insurance policies. Unlike other loans, life insurance loans don’t report to your credit and don’t have an approval process. This is because you’re not borrowing money from the bank – you’re borrowing it from yourself. When you borrow from your life insurance, you’re technically borrowing against the cash value of your policy.
While I don’t know which company you’re insured with, SxS Dreamer, taking out a lone against your indexed universal life plan should be fairly simple. Most life insurance companies only require you to fill out a loan request form and, once approved, you can expect to see the loan deposited in your account within days. All policies are different, however, and you may need to provide more documentation upon request. I recommend talking to your life insurance provider or one of our expert advisors to get the lay of the land before applying for a loan.
One benefit of borrowing from the cash value of your life insurance is that you can use the loan for pretty much anything. Additionally, life insurance loans come with lower interest rates than most other forms of consumer loans.
Borrowing Against Your Cash Value Life Insurance
Some life insurance policies – such as term life policies – do not have a cash value component to borrow against. Luckily, you have an indexed universal life (IUL) insurance policy. Because your IUL plan builds cash value, you can borrow against it. The same would apply if you had a whole life policy.
Generally, you can borrow from any life insurance plan that builds cash value. However, your policy’s cash value needs to be able to cover the loan. Therefore, you’ll need to check the balance of your policy’s cash value before determining your loan amount.
Paying Back Your Life Insurance Loan
Life insurance loans differ from traditional loans because there is no minimum monthly payment. No monthly minimum payment means you can make payments whenever you have extra room in your budget to do so. Additionally, life insurance loans come with significantly low interest rates, which makes paying the loan off more manageable.
However, the downside of no minimum payments is that you can accrue a lot of interest if you don’t consistently pay down the loan on your own schedule. If the interest gained plus the outstanding loan balance exceeds the policy’s cash value, it can cause the policy to lapse.
Cash Value Life Insurance Loan FAQs
I hope I was able to answer your questions, SxS Dreamer. I’m including a few life insurance loan FAQs, just in case.
What happens if I don’t pay back my loan?
If you don’t repay your loan during your lifetime, your life insurance company will deduct the money owed from the death benefit.
Will I be taxed on my life insurance loan?
The IRS does not recognize loans taken from life insurance policies as income. So, in most cases, you will not be taxed on the money you borrow.
What risks are there when borrowing from life insurance?
The cash value in your policy earns interest every year. However, the less cash you have invested in your policy, the less interest you make. That means continuous borrowing will decrease your interest earnings. Additionally, accrued fees from taking out a loan can build over time and your policy can lapse if you are not making sufficient payments on the loan. If your policy lapses, you’ll not only lose the security of your life insurance but the IRS will also tax the money you withdrew for your loan.
Use Your Loan, but Use It Wisely
As you can see, SxS Dreamer, having the right insurance is incredibly important if you want to borrow against your life insurance policy, and understanding how your loan works is vital. Leveraging a low-interest loan with no monthly payments could come in handy when purchasing that SxS, but you should first talk to a qualified life insurance advisor before making any big moves or taking out any loans.