In addition to the death benefit, your permanent* life insurance** (whole life, universal life, variable universal life) can build cash value that you can borrow against. While you can take out a policy loan for just about any reason, it's best to reserve policy loans for unexpected emergencies or for special needs such as educational expenses.
But before taking out a policy loan, consider the following information to help you understand what you should know before and after borrowing against your life insurance policy.
What you need to know about policy loans
When you take out a loan against your life insurance policy, it's important to understand what can happen if you don't repay your loan. A policy loan is just like any other type of loan in that until it is repaid, interest will accrue; and if the interest is not paid, it will be added to your loan balance, increasing the amount you owe.
What you need to know is that if you were to die before the loan's outstanding principal and accrued interest are paid, the amount will be deducted from the death benefit of your life insurance policy. For this reason, be cautious about borrowing too heavily against your policy because you could be jeopardizing the very reason for purchasing insurance in the first place - the security and welfare of your beneficiaries. Furthermore, there are potential tax implications should your policy lapse with an outstanding loan.
Before taking out a loan
It's always a good idea to speak with your financial advisor or insurance professional when considering a policy loan. A professional can better advise you as to the financial impact a policy loan can have on your policy, as well as other options that may be available to you. For example, they can weigh your immediate financial need against the potential future impact of loan interest accumulation and a reduced death benefit. If you do take out a loan, ask to see a policy illustration that can show the impact of your loan on your policy's death benefit.
Be a responsible borrower
Policy loans do not come with a repayment schedule and are not required to be repaid. This means that you may elect to repay some, all, or none of the loan. However, it's best to always keep track of your loan and unpaid loan interest accumulation. If you are unable to repay your loan, talk to your financial advisor or call your insurance professional to discuss your options.
Here are some additional tips when taking out a policy loan:
- Monitor your loan balance regularly in comparison to your cash value.
- Formulate a disciplined loan repayment plan and make regular scheduled payments.
- Pay the interest on the loan every year to prevent your loan balance from increasing.
The ability to take loans on your policy is a valuable feature of permanent life insurance. Just be sure that your short-term needs don't jeopardize your family's financial protection.
*As long as required premium payments are timely made.
**Variable Universal Life cash values are likely to fluctuate due to their investment in stock and/or bond markets.