Life insurance is a versatile financial planning tool. In the event of your death, it provides money for your loved ones to replace your lost income and creates liquidity to pay taxes and other expenses. And if you purchase “permanent” life insurance, such as whole or universal life, it also serves as a tax-advantaged savings vehicle.
One valuable benefit of permanent life insurance policies is the ability to borrow against their cash value. If you need money for college tuition, medical bills, a down payment on a home, or other expenses, life insurance policy loans offers several important advantages over traditional bank loans, lines of credit, and credit cards. But they also have some significant disadvantages, so it’s critical to weigh your options carefully.
Here’s a quick review of the pros and cons:
- Low costs. Typically, life insurance policy loans are available at lower interest rates than bank loans or credit cards, and fees and closing costs are minimal.
- No questions asked. So long as you have sufficient cash value to cover the loan, there’s no credit check, income verification, or detailed application. These loans do not appear on your credit report.
- If you’re eligible for a policy loan, you can usually receive the funds in a matter of days.
- Repayment flexibility. You can repay the loan according to your own schedule or even choose not to repay it (although, as discussed below, this may lead to some unwelcome consequences).
- Risk of reduced benefits. If you fail to repay the loan — either because you choose not to or you die before you get the chance — the outstanding amount (including accrued interest) will be deducted from the death benefit payable to your beneficiaries.
- Risk of policy lapse. Depending on the amount you borrow, the interest rate, and your repayment schedule, the amount you owe can increase quickly. If the outstanding amount grows beyond the policy’s cash value, there’s a risk that the policy will lapse, depriving your loved ones of death benefits and, in some cases, leaving you with an unexpected tax bill.
Be aware that you can’t borrow against a life insurance policy unless you’ve accumulated enough cash value to cover the loan. If your policy is relatively new, it may be years before the cash value grows large enough to make this a viable option.
Do Your Homework
If you’re faced with mounting expenses, a life insurance policy loan can be a cost-effective alternative to traditional financing sources. Before you go this route, however, it’s a good idea to consult your financial advisors to discuss the pros and cons of various alternatives and choose the option that’s best for you.