Understanding Life Insurance Loans

Understanding Life Insurance Loans

If you need money in an emergency, one place to look is your insurance policy. That is, if what you have is permanent life insurance – available as either “whole life” and “universal life ”.Unlike term life insurance, which has a set time limit on its coverage period and does not accumulate cash value, universal life does have a cash component, especially later on. “In the early years of the policy, most of the premium goes to funding the indemnity benefit. As the policy matures, cash value increases,” says Luke Brown, a retired insurance lawyer in Tallahassee, Fla., who operates YourProblemSolvers to help consumers with insurance, healthcare and consumer issues.

How Much, How Soon:-As cash value builds in a whole or universal life insurance policy, policy holders can borrow against the accumulated funds. Life insurance policy loans have one distinct advantage: The money goes to your bank account tax-free.Insurers generally make no promises as to how fast or to what extent the cash value will increase. So it’s hard to know exactly when your policy will be eligible for a loan. What’s more, insurers have varying guidelines outlining how much cash value a policy must have before you can borrow against it – and what percentage of cash value you can borrow.Your policy is likely to have sufficient cash value to borrow against “typically after the 10th year the policy is in force,” says Richard Reich, president, Intramark Insurance Services, Inc. a life insurance agency in Glendale, Calif.Something else to know: This loan isn’t taking money from your own cash value. “You are actually borrowing from the insurance company and using your policy’s cash value as collateral,” says Reich.

No Need to Repay:-One attractive aspect of loans against cash value is that you don’t have to repay them – a huge benefit in an emergency.If you do pay back all or a portion of the loan, options include periodic payments of principal with annual payments of interest, paying annual interest only or deducting interest from the cash value. “Loans have an interest rate like any other type of loan. It tends to be in the 7% to 8% range, which is high in our current environment,” says Reich. Interest will be fixed or variable, depending on your policy.There is a good reason to repay the loan if you can. “If the loan is not paid back before death, the insurance company will reduce the face amount of the insurance policy when the claim is paid,” says Ted Bernstein, CEO, Life Insurance Concepts, Inc., a life insurance consulting and auditing firm in Boca Raton, Fla.The accumulated interest can cut deeply into the benefit: “If the policy loan remains outstanding for many years, the amount of the loan grows and grows due to the added interest,” Brown cautions. “That puts the policy at risk of not providing beneficiaries any money upon the death of the insured.“At the very least, interest payments should be made so that the policy loan does not effectively grow,” Brown adds. That gives you a better shot of having money left to pay out after your death.

When Life Insurance Loans Make Sense:-Here are some financial situations when a life insurance loan might be a sensible choice:

   You can’t qualify for a standard loan or need cash really, really fast. Because the money is already within the policy and immediately available, it’s a quick source of immediate funds for a new furnace, medical bills or another emergency, with no credit check required. Even if you qualify for a traditional loan from a bank or credit union, a life insurance loan could be a valuable stopgap if you t don’t have time to wait for your application to be processed. When the traditional loan comes through, immediately use it to repay the life insurance loan.
   You can’t afford your policy’s annual premium. Don’t let a life insurance policy lapse because you can’t afford the payment. A loan can keep the policy in effect as long as the death benefit is greater than the amount of the loan.
   Your only other loan options have much high interest rates. Before paying a higher interest rate for a loan or pledging additional collateral for a traditional loan, consider taking out a life insurance policy loan, says Bernstein. “Since there are no loan terms such as repayment dates, renewal dates or other fees, compared to traditional loans, life insurance policy loans can be very competitive,” he says.

The Bottom Line:-Choosing if and when a life insurance loan is right for you is subjective, Reich says. “You have to look at which is more important; the immediate need for the cash or your family’s need for the death benefit. Understand that any outstanding policy loans will be deducted from the death benefit, resulting in a smaller benefit for your family.”

When to Borrow Against Your Life Insurance Policy:-Most people buy life insurance to protect their families from the loss of their income if they were to die. However, certain types of life insurance offer the ability to take a loan against the policy.Life insurance policy loans have major advantages over bank loans or credit cards, but they are still loans — and if you don’t pay them back, there are consequences.

What is cash value life insurance?:-Unlike term life insurance, which pays out only if you die during the policy term, permanent life insurance policies (sometimes called cash value life insurance) pay a death benefit no matter when you die. Part of your premium also goes in a separate account that builds up cash value. Depending on your type of permanent life insurance, this cash value may be a part of your death benefit, or an addition to it. You can also borrow at least a part of this cash value, depending on the specifics of your policy.

Advantages of a life insurance policy loan:-If you’re in need of emergency cash, you have a few options: You might apply for a personal loan from your bank or put expenses on a credit card. While both of these solutions have their places, a loan from life insurance cash value has a few big advantages.

No credit check:-If you have enough cash value in your life insurance policy, you can borrow from it, no questions asked. There’s no application process, unlike with bank loans. You simply fill out a form and receive a payment. And these loans don’t show up on your credit report, unlike credit card debt.
    
Low interest rates:-Personal loans have notoriously high interest rates, even at mainstream banks. The average rate on a two-year personal loan is 10.47%, according to the latest data from the Federal Reserve, and the average interest rate for a credit card is 13.68%. It’s very possible that your life insurance company will charge a lower interest rate than either option, though it’s always worth checking.
    
No timetable for repayment:-Unlike a bank or a credit card company, the life insurance company won’t come after you to repay your policy loan. You should absolutely repay it, but you can do it on your schedule. Be aware, though, that if your policy lapses before you fully repay the loan, you may end up owing tax on some or all of the portion you haven’t paid back.

Disadvantages of a cash value loan:-Of course, any method of getting quick cash has drawbacks, and life insurance loans are no exception:

Reduced death benefit:-If you don’t repay your loan during your lifetime, it will reduce your death benefit. In some cases, this may be all right, but it could also put your family in a tough position.
    
You’re limited by your cash value:-It takes permanent life insurance policies years to build up any significant cash value. In the early years of your policy, you may have very little available to borrow, if any.
    
You could lose your policy:-Life insurance policy loans tend to have lower interest rates, but they do still have them. And because the interest is often simply subtracted from your cash value, it can sneak up on you. If your loan plus interest exceeds your policy’s cash value, the policy could lapse entirely, and you could face tax consequences.

So, should you borrow from cash value?:-If you need to cover an unexpected medical bill or can’t pay your mortgage one month, a policy loan could be a good alternative to running up a credit card balance.But loans from whole life insurance policies loans aren’t your only option. If you really need cash, you may be able to borrow from your 401(k) or IRA as well, though those loans have their own downsides.If you think your family will need your full death benefit, approach any life insurance loans very carefully. Keep an eye on your accrued interest, and if your family needs the entire death benefit, don’t take a loan without a plan to pay it back.

Content Credit : DollarBlog

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