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Life insurance covers were developed to cater to the needs of beneficiaries upon the death of the insured. But later many products evolved to make it more attractive.
Currently, it incorporates saving and investment components. It is now possible to borrow money against the cash value of the policy. Universal and whole life insurance policies allow holders to access loans. These loans are usually availed by the insurance company or banks at a small interest rate.
How Does It Work?
When you borrow against a policy, you will be borrowing your own money from your insurance company. So you are under no obligation to pay it within a stipulated time frame.
Also, such a loan is easier to get compared to a bank loan because the lender will use your policy as collateral. If you are unable to pay the loan, they will recover it when the death benefits are finally paid out.
The trouble is that if you don’t pay it back, the interest gets compounded and added to the loan balance. When the sum of the loan and interest exceeds the cash value, the policy may lapse.
When to borrow using the cash value as collateral
You need to build some cash value to be able to borrow from the policy. You may need to contact your financial advisor to discuss the financial impact of such borrowing. They will also discuss with you the possible tax implication.
How to borrow
Typically, the loans are provided by the insurance company itself. Alternatively, other banks may use the policy as security to give the holder a loan. The maximum amount will borrow depend on the surrender value and the value of the policy.
But in most cases, the amount of money you get will be a fraction of the policy’s surrender value. It could fall anywhere between 80-90% of the surrender value.
Documents required
To be able to access the loan, you need to fill a loan application form. The form should be signed by the policyholder and accompanied by the original policy document.
If you are borrowing from a financial institution, you need to include a deed of assignment. This document must be executed by the policyholder. You may also need to pay some nominal fee to help in the processing of the loan.
The process of borrowing
You may borrow a loan from your insurance policy to invest or for home repair purposes. If your kit has enough money, you will find the process much simpler than taking the traditional lawn.
Here are some of the things that you may need to do to get started.
Firstly, check the kind of policy you already have. A few policies may not allow the holder to borrow against them. Permanent policies and whole life insurance will allow you to borrow against them. Also, you can borrow against universal life insurance. So, if you own any of the policies, you can prepare yourself to start the process.
Secondly, if the policy permits you to take a loan, you should verify that it has enough cash value. Also, check out the amount of money you can borrow from them.
Once it is done, you need to consider the benefits of a life insurance loan vis-à-vis the traditional loan. It will help you make up your mind on whether to take the loan or not. It is also prudent that you check the downside of this loan. For instance, consider what will happen if you don’t pay the loan. Look at the tax consequences if the policy lapses.
Thirdly, if you are happy with the terms and conditions, get the necessary forms from the company. You may also download the forms from their website. Complete the loan application form following the policy’s guidelines. But ensure you provide all the information needed to allow for processing of the loan.
The fourth step is to determine the payout. If your application is successful, you may be required to choose the payout method. You will be asked how you want the money disbursed. Some company pegs the payout method on the purpose of taking the loan. Also, you can choose to have the money paid through check or transferred to your bank account.
Lastly, ensure that you keeping track of the loan. Your relationship with the company should not end at the point you receive the check. You should monitor the loan and ensure that it does not affect your life insurance policy.
Monitor the loan balance regularly and compare it with the policy’s cash value. Ensure you pay the loan as per the repayment plan. If you die before completing the repayments, your beneficiaries will receive less money.
Benefits
- It avails money that one may need to meet emergency needs.
- You do not need to go through the long loan application process.
- No credit checks if you have built a sufficient cash value in the policy.
- Even when you don’t pay on time, it keeps your credit report clean.
- It allows you to acquire loans at the lowest rates possible.
- If you are unable to repay the loan, it will be deducted from what the beneficiaries were to receive when you die.
Cons
- You need to build enough cash value before you can be allowed to take the loan.
- The beneficiaries run a risk of a reduced death benefit if you die before repaying the loan.
- If the amount of unpaid loan and interest accumulates, you risk losing the policy.
- If the policy lapses before paying the entire loan, it will attract income taxes.
- Once you use it as collateral to take the loan, you will not have protection from creditors.
Conclusion
If you have accumulated huge cash value, you will be eligible for a loan from your insurance company. But ensure you speak to the insurance adviser before you apply for the loan. The company charges a small interest on the loan. It makes it affordable than the traditional bank loan. Lastly, consider paying the accruing interest out of pocket. It prevents the policy from lapsing.
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