If you have a permanent life insurance policy or a whole life policy, you may want to consider borrowing against its equity. Borrowing against a life insurance policy is a fairly easy process, but there are some drawbacks that you might also want to consider.
Borrowing Against a Life Insurance Policy
Every company has their own rules, but in general a life insurance policy will let you borrow up to a certain amount of your policy in cash. For instance, a $200,000 policy may allow you to borrow 25% of its value (or $50,000) in cash at a rate of 6%. You’ll get the money back and then you’ll be able to pay it back to your policy in installments. Once it’s paid off fully, it’ll be as though the loan never happened.
Pros: Easy, Fast, and Simple
By far the largest benefit of borrowing against a life insurance policy is that it comes pre-approved. You don’t need to justify your need for a loan against your life insurance policy: the money is essentially already yours. If you have bad credit (or if you simply don’t want to go through the approval process), a life insurance policy loan is the most expedient way. You also won’t need to negotiate terms: in general, the terms are already set by the policy company. Finally, you don’t actually need to pay the loan back. You can just take out money from your insurance policy permanently… but, obviously, there is a catch to this. Interest will still be accruing.
Cons: High Interest and Tax Consequences
As mentioned, you still need to pay interest on loans that you take out on your own behalf. But it isn’t just this: the interest will compound too. So you’ll actually be paying interest on the interest over time. The earlier you are in your life insurance policy, the longer this interest will compound for. Ultimately, it may balance out the profit that you’re making. The interest rates for a life insurance loan also tend to be higher than a home equity loan (but can be lower than many personal loans or cash advances). Finally, there are tax consequences to taking out this money early.
So should you borrow against your life insurance policy? It all depends on your personal financial situation. Remember that the amount you borrow will be taken out of your eventual payout with interest — but if you need the money, it is often available more easily through your life insurance than anywhere else.