Borrowing against Life Insurance

There are many different types of life insurance, but the biggest factor to consider when purchasing a policy is whether to get term or whole life. Term life insurance provides you with a death benefit for a pre-determined number of years, and is one of the least expensive types of life insurance. It is well-suited for many situations, and is especially useful for younger individuals who may have families still at home, or for people who may have just made a large purchase such as a house. However, term life has no cash value.

Whole life insurance policies on the other hand, provide both a death benefit and cash value. Your monthly premium is higher, but your policy is an actual asset and will increase in value over time. The fact that your whole life insurance policy is an asset gives you a major advantage, in that it is something you can cash in or borrow against in an emergency. Of course, the death benefit will be reduced proportionately if you reduce the value of the policy by cashing in some of its equity. If you die before the loan is repaid, the balance due would be taken out of the death benefit, with the remainder distributed to your heirs.

In most cases, you will not have any significant asset for at least the first three to five years of your policy. The policy is not like a savings account, where you can borrow or take out the exact amount you have put in. That's because only part of your premium is actually going to accumulate into an asset, part of it is still going to pay for the death benefit.

If you do have enough equity in your life insurance policy, you may be able to use it as collateral for a loan, or cash it in outright. As a loan, you must pay it back as you would any other type of loan. Because the loan is secured against a solid asset however, you are likely to be able to get an attractive interest rate, and this may offer you a major advantage. The first thing to consider is the cost of money. If you are in need, what are the alternatives to leveraging your life insurance, and what will those alternatives cost? If your credit is sterling enough and you can obtain a low-interest signature loan without using your life insurance as an asset, then take the signature loan and leave the insurance policy unencumbered. However, if the only way you can raise money is by getting advances on credit cards that carry interest rates of 18 to 24 percent, it's likely you'll be better off borrowing against your life insurance.

When you first purchase your life insurance policy, think ahead and decide whether you may need to borrow against it in the future. Policies will differ, but most will have a loan clause that will allow a loan to be taken against it for as much as 90 percent of the policy's cash value. 

Information is for educational and informational purposes only and is not be interpreted as financial or legal advice. This does not represent a recommendation to buy, sell, or hold any security. Please consult your financial advisor.