Imagine having a financial resource that may not depend on your credit score or repayment ability in the same way traditional loans do. For many, a life insurance loan through a permanent life insurance policy may serve this purpose, offering additional features beyond a death benefit to policy owners and beneficiaries.
Knowing how to borrow against life insurance is essential to unlocking and maximizing financial flexibility. While most people view life insurance as a tool for the future, borrowing against an insurance policy may allow you, if sufficient cash value is available, to access funds during your lifetime.
Learn how life insurance loans work and the potential advantages and risks they may carry.
How do life insurance loans work?
When you have a life insurance policy that generates cash value (depending on funding, costs, and performance), you may be able to borrow against the policy’s available cash value, which may reduce the death benefit if not repaid. This is a life insurance loan taken out with the insurance company rather than a bank, credit union, or credit card company.
Borrowing against your life insurance policy typically works in three steps:
- Accrue cash value: The amount of cash value your life insurance policy has built up affects how much you can borrow. While there is no general floor for this amount, it often varies by insurer.
- Request the loan: Because policy loans are generally secured by your policy’s cash value, insurers typically do not require a traditional credit application, though procedures vary by carrier. Simply follow your carrier’s procedures to request the funds from your insurer.
- Receive the funds: With the cash value of your policy as collateral, the insurer loans you the requested funds with generally no restrictions on how the money can be used, subject to applicable law and policy terms.
While life insurance is a solid financial planning tool, when and how much you may borrow often depends on the type and age of a policy.
When can I borrow from my life insurance policy?
You may be able to borrow from your life insurance policy as soon as you have accrued enough cash value to borrow against. However, it can take anywhere from a few months to 10 years to build up a new policy with enough funds to borrow from (depending on your premiums). And some policies may have a minimum waiting period from policy issuance before you may be able to borrow against it.
Additionally, since there are no restrictions on how a life insurance loan may be used, you may choose to borrow money when:
- You need quick cash: Working with an insurance provider may not require minimum income documentation or hard credit checks, depending on carrier practices.
- You want to avoid other forms of collateral: Instead of using your car or home as collateral, your policy may serve this need.
- You need flexible repayment options: Typically, repayment schedules are flexible; however, interest accrues, and unpaid balances may reduce policy values and death benefits.
How much can I borrow from my life insurance policy?
Depending on the insurer and policy terms, you may be able to borrow a substantial portion of the available cash value, often up to approximately 90%. Life insurance loans are generally not treated as taxable income if structured properly and the policy remains in force, but they could also accrue interest and reduce the policy's final death benefit.
How to borrow against life insurance
Besides being the policyholder, there are additional requirements and steps to securing a life insurance loan:
- Check your policy type: Confirm that you own a permanent life insurance policy instead of term life insurance, since not all policies have a cash value component.
- Ensure you have the cash value: You must wait until your cash value has accumulated sufficiently under your policy terms and you’ve satisfied all other conditions before borrowing against it.
- Confirm how much you may be able to borrow: You may be able to borrow up to approximately 90% of your cash value, but it may be beneficial to leave a small buffer in the policy to cover ongoing fees and prevent lapses.
- Consider the potential tax implications: Policy loans are generally not taxable if the policy remains in force and is not classified as a modified endowment contract (MEC). The IRS may treat the borrowed amount as taxable income if you surrender the policy or it lapses.
- Request the loan: After confirming eligibility, submit a loan request with your provider. Funding timelines vary by insurer but are often completed within several business days after approval.
- Confirm the loan terms are clear: Before finalizing the request, review the current interest rate and its application to understand how this could affect your beneficiary's death benefits.
Types of life insurance you can borrow against
Permanent policies are the only types of life insurance you can borrow from. Below, we break down the three types of permanent life insurance policies that are eligible for life insurance loans.
Whole life insurance
Known as the most traditional form of permanent coverage, whole life insurance offers a set death benefit and a fixed premium. Compared to universal life, whole life policies are less flexible, but still offer terms that support life insurance loans, such as:
- A portion of the premium is diverted to build up cash value.
- The policy grows at an issuer-set minimum.
- The policy is designed to last the holder's entire life, assuming required premiums are paid.
Policyholders may be able to borrow from a whole life policy once enough cash value has accumulated, typically after the first few years.
Indexed universal life insurance
Indexed universal life (IUL) insurance policies allow you to adjust your premiums and death benefit as your financial situation changes. The cash value growth is connected to a stock market index, providing the potential for interest credits tied to index performance, subject to caps, participation rates, spreads, and insurer crediting methods. These policies are also typically subject to a minimum crediting rate (often 0%), which limits index-linked losses but does not eliminate policy costs or the risk of reduced policy value due to charges.
Some policyholders use IUL policies as part of strategies sometimes referred to as “infinite banking,” though whether this is a good strategy for any given person depends on individual circumstances. Depending on the policy’s loan structure (e.g., participating or non-participating loans), some or all of the remaining cash value may continue to receive interest credits, subject to policy terms and loan interest charges.
Variable universal life insurance
Variable universal life (VUL) insurance policies allow you to invest your cash value directly into sub-accounts that function like mutual funds. Because VUL policies involve investment risk, including possible loss of principal, policy values and loan sustainability may fluctuate significantly. By using your policy to invest, you could increase your accumulation potential, but you may also experience risky fluctuations and substantial downside based on investment performance.
When you borrow against these policies, you gain access to a versatile source of liquidity that may be used for any purpose. However, owners of VUL policies should monitor their investments especially closely to keep an eye on the cash value remaining sufficient enough to support the loan and keep the policy active.
Pros and cons of life insurance loans
There are a few factors that may make life insurance loans more beneficial than a traditional bank loan. However, it's important to understand how they work and the cost of borrowing against your life insurance before taking action.
Here are a few of the common pros and cons:
