The Pros and Cons of Borrowing Against Your Life Insurance

Traditional life insurance was originally developed to provide a death benefit after someone dies, but products have evolved to incorporate a type of savings or investment option.

Some policies can even provide a cash value component. Being able to borrow against a life insurance policy in an emergency sounds great, but you should understand the pros and cons beforehand so you don’t put your policy or premium at risk.

What Is a Policy Loan?

Sometimes referred to as a “life insurance loan,” a policy loan is issued by an insurance company and uses the cash value of a person’s life insurance policy as collateral. As cash value builds in a whole life policy, holders can borrow against the accumulated funds are generally untaxed. Keep in mind that this is only available with whole life insurance — term life insurance policies generally don’t accumulate any cash value over time. 

Before You Borrow Against Your Life Insurance Policy

If you have the option of borrowing from your life insurance policy, the first thing you need to decide is if borrowing makes sense in your circumstance. This is an important discussion to have with your agent or representative. They can provide an “in-force illustration” that shows how taking a loan would impact your policy. They can also help explore other options and weigh the pros and cons.

Pros of Borrowing from Life Insurance

• You can skip the lengthy loan application process.
• You’re able to borrow without a credit check or any questions from a lender if you have built up cash value on your policy.
• Policy loans don’t show up on your credit report, unlike a credit card debt or bank loan.
• You can repay the loan on your own schedule.
• You have the option of not repaying the loan and having it deducted from the policy’s death benefit instead.
• You’re protected from creditors for all the cash value locked up in your policy.

Cons of Borrowing from Life Insurance

• You may have to wait several years for the policy to build a cash value.
• You could run the risk of a reduced death benefit for your family if the loan isn’t repaid while you’re living.
• There’s a risk of losing your policy if the amount of interest plus the unpaid loan adds up to more than the remaining cash value of the policy.
• If you take the cash value as a loan, there is not any protection from creditors.
• If you take many loans over many years, and that causes the policy to lapse, you could owe income tax on the amount you borrowed that was greater than your premium paid.

5 Things to Consider Before Borrowing From a Life Insurance Policy

Before you move forward on a policy loan, you need to have a serious discussion with your agent about what happens when you borrow from your life insurance policy to make sure you understand the consequences and risks. There are hidden costs that you may not initially realize, so it’s important to make sure it is the best option for you.

1. Discuss how the loan and interest will impact your policy to make sure that the death benefit portion of your policy is not threatened.
2. Find out if you’ll have to pay an “opportunity cost.”
3. Make sure you can afford to pay the interest and any other fees. Not all policies are the same and everyone’s circumstances are different.
4. If you can’t pay back the interest, think twice about borrowing.
5. If you are relying on the dividends of your policy to pay the interest, look through the details. Borrowing the cash value reduces the amount of available collateral for the loan, which reduces the dividends and generates less money to cover those interest payments.

Taking out a policy loan can involve complex financial implications — your Farm Bureau agent can help you navigate the process and ensure that it is the right option for you.