Many permanent life insurance policies come with a cash value component. This cash value accumulates over time as you own the policy, and you have the option to borrow against it. Because of this feature, many people use permanent life insurance policies as long-term investments.
But how soon can you borrow against these types of life insurance policies once you open them? And how does borrowing against your policy affect your insurance? Here’s everything you need to know about using this cash value feature of your life insurance policies.
How do cash value components work?
Whole life, universal life, and other types of permanent life insurance policies often come with cash value components. Term life policies do not typically come with cash value.
If your life insurance policy has a cash value feature, that means that part of your premiums each month goes into a separate account. This accumulates over time separately from your death benefit, which stays the same. There are a few different ways that cash value can grow in a life insurance policy. Some types of cash value policies accumulate at a fixed rate over time. Other policies grow at a rate commensurate with an index or with the market itself.
You do have the option to take out a loan from your cash value life insurance policy. However, you will have to pay it back in order to keep the policy in place and ensure your beneficiaries can access your death benefit. The cash value serves as collateral for a loan from your insurance provider. This means that the cash value stays attached to your policy and continues to grow as you pay your insurer back.
You can also access the cash value by surrendering the life insurance policy, but then your coverage would not continue. Some policies will also allow you to make partial withdrawals from your cash value instead of taking out a loan. However, this will reduce your total death benefit and may come with penalties, so it isn’t always the best move from a financial perspective.
When can you borrow against your life insurance policy?
You won’t be able to borrow money from your life insurance policy right away. Insurers have policies in place that prevent you from taking out a loan from your policy too early. You’ll need to read the terms of your life insurance policy to determine when you can start taking out
Most insurers will require your cash value to reach a certain amount before you can borrow from it. It often takes between 5 and 10 years for your cash value to reach this point, but it can vary depending on what type of policy you have. If your cash value is tied to the market, it could grow much faster than a policy that grows at a fixed rate.
How do you take a loan against your life insurance policy?
In order to take out a loan against your life insurance policy, you’ll need to get in contact with your insurer. You’ll typically need to fill out a form to indicate where you’d like to transfer the money, how much you want to borrow, and other key pieces of information. You may also need to provide proof of identity. Once your insurer has processed your forms, you will typically have access to the funds within a few days.
The amount of money you can borrow against your life insurance policy will vary depending on who your provider is. Most insurers allow you to take out up to 90 percent of your cash value amount at one time. If you’re taking out a particularly large loan, to pay for a home, for example, you may need to have your loan request notarized.
Most insurers don’t require you to pay back the loan within a specific time frame. However, you will need to pay interest on the loan, which compounds over time. This serves as an incentive to pay the loan back quickly. If you pass away before you finish paying back the loan, the total outstanding amount would be deducted from your death benefit.
What are the advantages of borrowing against your life insurance policy?
One of the reasons why so many people choose permanent life insurance policies over term life insurance policies is the cash value feature. Permanent life insurance policies can be very expensive when compared to term life insurance policies, but the cash value feature can balance this out from a financial perspective.
There are many reasons why you might opt to borrow against your life insurance policy rather than taking out a traditional loan from a bank. The first is that you can pay the loan back whenever you want. This makes it a good option for those who might need more flexible repayment terms than a bank can provide.
Additionally, borrowing against your life insurance is much faster and easier than taking out a traditional loan. You won’t have to go through an approval process, since you are using the cash value of your insurance policy as collateral. This makes it a great option if you need funds immediately for an emergency moving expense or medical bill, for example.
What are the disadvantages of borrowing against your life insurance policy?
There are some disadvantages to borrowing against your life insurance policy. It’s important to be aware of these before taking out a loan. The biggest disadvantage of this strategy is that the amount outstanding on the loan will be deducted from your death benefit if you were to pass away.
The other major disadvantage of borrowing against your life insurance policy is that you will have to pay back compound interest over time. While these interest rates aren’t as high as a traditional bank loan, they can still add up very quickly over time.
While permanent life insurance policies aren’t the best choice for everyone, they can be a very helpful financial planning tool when used effectively. Borrowing against your life insurance policy can be an easy and quick solution to a financial emergency without the challenges of a traditional loan.
