Is it Ever Okay to Borrow against your Life Insurance Policy?
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If you have a permanent life insurance policy whether it is whole, variable or universal then you know that the policy increases in cash value because of the fact that there is an investment portion built in to the life insurance policy. One of the benefits of having a permanent policy is that you can borrow against your policy as long as it’s not a fixed term life insurance policy. The question to consider is whether or not it is ever a good idea to borrow against your life insurance policy. In order to answer that question, we must consider a few items and the risk associated with taking such an action.
Understand Interest Accumulation
If you borrow against your life insurance policy, you will be charged interest on that loan. If the interest is not paid, it will be added into the loan amount and then it will be compounded. What that means for you is that you will be paying interest on the interest, which is never a good thing. That said,if you take a loan then from your life insurance policy, you want to make sure you can repay it and that you can make interest payments on the loan first.
Understand Non-Standard Repayment Options
If you take out a loan against your life insurance policy, repayments may not be required of you. However, not paying at least the interest off your loan may deplete or eliminate the cash value from your policy and may affect the policy itself. Given this, it is important to consider any other options you may have and whether or not borrowing from your life insurance policy is a good idea.
Understand Other Loan Costs
If you have a variable life insurance policy, there may be something called an opportunity cost associated with it. The opportunity cost is the difference between the amount of interest your loan was earning at the time it was in the investment funds and the amount that it earns once it is transferred to a fixed interest fund. You may be responsible for paying the difference in interest before the move.
Understand Where the Money Comes From
If you have a permanent or whole life insurance policy then you can borrow up to any amount that you have as a cash value in your policy. The amount that you request as a loan amount will be equal to the amount transferred to a more secure investment fund. If you cannot pay the loan back or you are not able to pay the interest on the loan, the amount of the death benefit once you are deceased will be reduced by the amount of the loan and interest, possibly affecting your beneficiaries.
As you can see, there are many important and complex issues to consider when you look at borrowing against your life insurance policy. You should understand that the main purpose of a life insurance policy is not to act as a funding source for loans you feel you need, but as a way to provide for your family in the event of your death. In general, you should consider other options first and you should make sure you thoroughly understand how taking a loan out against your policy will affect your policy. Discuss all the particulars with your life insurance issuer prior to taking action and consider talking to a certified professional financial advisor or life insurance agent qualified to speak authoritatively on life insurance products. In general it is not a good idea to take a loan out for something that you don’t need or if you have no idea how you would repay the loan. Remember to never consider a loan, even from a cash value life insurance policy as “free money.”
Photo courtesy of: Loren Kerns
John is the founder of Frugal Rules, a dad, husband and veteran of the financial services industry whose writing has been featured in Forbes, CNBC, Yahoo Finance and more.
Passionate about helping people learn from his mistakes, John shares financial tools and tips to help you enjoy the freedom that comes from living frugally. One of his favorite tools is Personal Capital , which he used to plan for retirement and keep track of his finances in less than 15 minutes each month.
Another one of John's passions is helping people save $80 per month by axing their expensive cable subscriptions and replacing them with more affordable ones, like Hulu with Live TV.