Borrowing Against Life Insurance: The Pros and Cons

“A bank is a place that will lend you money if you can prove that you don’t need it.” 
Bob Hope

Credit Loan Mortgage Signpost Showing Borrowing Finance And DebtTwo weeks ago we asked the question, “Should you borrow against your life insurance policy?” Today, we continue the topic by looking at the advantages and disadvantages of borrowing against a life insurance policy.
The Advantages of Borrowing Against Life Insurance

  1. It’s simple and relatively quick. There’s NO QUALIFICATION process, no need to fill out an application, have your income or credit checked, nor brace yourself for high fees and taxes (in most situations, see below exceptions.) You’ll have your loan in 5-10 business days for most companies, and occasionally they have faster options.
  1. It’s flexible. You can borrow about 95% of the cash value amount of your whole life policy from most mutual insurance companies. And when you borrow against your insurance policy, you can design your own repayment schedule, modify it as needed, or even continue down the path of life without repaying it if your circumstances require. In contrast, most types of non-insurance loans have strict repayment schedules that may or may not work well for you.
  1. It’s cheaper than you think. Life insurance policy loans are running in the 4 – 8% range right now. But that does not equate to a bank loan for the same amount. This is because you’re borrowing against an account that likely has an internal rate of return of 4-5%, depending on your age. And since you are borrowing against your cash value, not borrowing the cash value itself, your cash value continues to grow and earn dividends, which offsets the interest on the policy loan.
  1. It’s (probably) not a taxable event. Although there are exceptions, typically the IRS will never know that you borrowed the money. Like taking a second mortgage or line of credit against a rental property, a policy loan is not considered “income” in most situations.

What happens to the interest that you pay?

There is a misunderstanding with borrowing against your life insurance. Sometimes people say that you’re “paying yourself interest,” which is not exactly accurate. You’ve neither borrowed from yourself nor are paying yourself interest. You’ve borrowed from the insurance company, using your cash value as collateral. The interest is likewise being repaid to your insurance company.

However, in a roundabout way, the interest benefits all policyholders because in a mutually-owned insurance company, policyholders are paid dividends which represent profits. In a nutshell, interest on loans made to policyholders become earnings that later become dividends.

As the Truth Concepts blog states in a post entitled, “Life Insurance Loans: Where does the interest go?

This is a good deal for everyone because the insurance company earns money, the owner of the policy gets use of the money while at the same time their cash value keeps growing, and all the other policyholders know the insurance company is investing their money properly, since the interest charged is reflective of the rates in the marketplace.

The Disadvantages of Borrowing against Life Insurance

  1. Fewer assets for yourself. One disadvantage you always have when borrowing money from a life insurance policy (or a property) is that you’ll have fewer assets to use or borrow against (unless you are leveraging your asset to acquire a greater asset), plus of course interest to pay. So you always want to evaluate whether the loan is needed or not, or whether you can simply reduce your spending and avoid taking the loan in the first place.

    Always take the time to talk with your advisor or agent to understand the impact that borrowing against your policy will have! Don’t assume that just because you have “permanent life insurance” that you can or should borrow against it. Some forms, such as Universal Life and Equity Indexed Universal Life (EIUL) operate very differently from whole life insurance.(We’ll cover EIUL in another post soon. If you want to make sure you get updates, please opt-in here to receive our Prosperity Pack, and you’ll receive a periodic newsletter of our most recent posts, as well as some great resources to help you accelerate your prosperity.)

  1. Fewer assets for heirs. Although you don’t “have to” replay loans against your cash value, unpaid life insurance loans (and their interest) reduce total benefits to beneficiaries.One solution to this quandary is to fund some Paid-Up Additions, or PUA’s, as you begin to repay the loan. With a PUA, approximately 95% of the money goes to cash value, and about 5% or so goes to incrementally increase the death benefit. PUA’s raise the cash value amount available to you for use in future years, while also raising the death benefit for heirs.
  1. Potential taxes. Outstanding loan balances may trigger a “tax event” (typically the issuance of an IRS Form 1099) if you borrow more than you’ve saved (due to growth) and choose to cancel or surrender your policy at a later date.Certain types of “cash-rich” insurance policies have been designated “modified endowment contracts” (or MECs) by the IRS. Loans against MECs are not tax-free. If you suspect that your contract might be an MEC, be sure to ask about the loan’s possible tax consequences before you borrow. (A properly structured whole life policy will not be an MEC.)
  1. Cash Value is your life insurance policy’s “emergency fund.” If a high percentage of the policy’s cash value is borrowed and premiums are not paid on time, the policy may lapse, resulting in the loss of coverage (the “death benefit” paid to the beneficiary) and possibly triggering a further tax event.

Is there a better option than borrowing against your life insurance policy?

That depends on the situation. In some cases, there could be better options that have even lower costs. For instance, it’s hard to beat a tax-deductible Home Equity Line of Credit (HELOC) at today’s rates of as little as 3% APR.

Of course, there are generally fees as well as interest involved in borrowing money against a property, and now many lenders are charging substantial prepayment fees for short-term borrowers. Since the real estate market crash, it has also become much more difficult to qualify for those loans. Both the borrower and the property must fit lending requirements, such as sufficient equity, a steady job with income several times any debt payments, and good credit.

Borrowing from or taking money from retirement accounts can generate fees as well as taxes, and due to employer plan restrictions, some investors find themselves unable to borrow against their 401k’s, even in emergencies. When they can borrow, they will be typically limited to $50k or 50% of the vested funds, whichever is less. And unless the reason is a down payment on a home, the funds must be strictly paid back within 5 years. Another major issue is that you’ll have to replace the borrowed funds with after tax dollars – which will then be taxed AGAIN at withdrawal! (unless it is a Roth)

The rules for IRA’s are even stricter. They are typically not acceptable as collateral and you can only access your funds for a 60-day period in what is considered a “tax-free rollover,” and that time frame is firm. Beyond the 60 days, you’ll pay income taxes, a penalty, plus lose the ability to put the money back in your IRA.

Should YOU to borrow against – or begin – a whole life insurance policy?  At Partners for Prosperity, Inc. we use Truth Concepts™  financial software to compare different financial strategies. We show investors how to build wealth with safety, apart from market risks and instabilities. We can help you consider opportunity costs, taxation, risk and returns, and more. Contact us  to find out more.

This entry was posted in CASH VALUE INSURANCE, INSURANCE ADVICE, INSURANCE AS AN ASSET, PERSONAL FINANCES, WHOLE LIFE INSURANCE and tagged , , , , , . Bookmark the permalink.

13 Responses to Borrowing Against Life Insurance: The Pros and Cons

  1. Kate4Kim@P4P says:

    Update – we have added two recent articles that give some additional details about borrowing against or withdrawing from your life insurance.

    “Should You Borrow Against Your Cash Value or Withdraw It?”

    “Borrowing Against Life Insurance: Why It Pays to Become Your Own Banker”

    We also invite you to opt-in at to get occasional fresh content in your inbox (you’ll also get our Prosperity Pack of resources at no cost.)

  2. Richard says:

    I have used my life insurance cash value to pay the current premiums and it accrues interest too. I monitor my death benefits to make sure they don’t get below my needs> i refinanced with a company in Chicago area, who works with banks to do the loans at lower rates with simplified application process. Paying 4% instead of 8%.

  3. Kate4Kim@P4P says:

    Yes, cash value is about the best collateral you can have, and at today’s rates, it can make more sense to borrow from a bank using the cash value as collateral than from the insurance company, as you discovered!

  4. thiza says:

    I want to know can i borrow money against my insurance policy ?

  5. Kate4Kim@P4P says:

    It depends what kind of insurance policy you have. Term insurance has no cash value, but whole life and other types often have cash value that you can borrow against very easily, especially if you have been paying premiums for a few years.

    If you’re not sure, contact the agent or advisor who sold you the policy, or locate your policy and call the company. If it says it is a “term life insurance policy” then it will not have a cash value component.

  6. Erik says:

    Here is my scenario:

    I have an unexpected situation where I need this cash.

    I am 46 and have had the policy for 10 years. I have a $100,000 universal life policy with State Farm. I can get $6600 cash out of it.

    My current monthly payments on the policy are $75.23. The agent worked up a scenario where if were to get another universal life policy in 2 years it would cost $170 per month. This seems like quite jump, but I do understand that I would be 12 years older that when I took out my current policy

    The agent told me that instead of closing out (surrendering) the policy, I could do a loan. She said that the interest is 8% (I’m not sure if that is fixed or variable).

    She also said I had the option of paying monthly on the loan with a minimum of $15 (I can pay more), or I could choose NOT to pay and at my death the 6600 plus interest would be taken out of the proceeds of the policy.

    So at my age, what would be the best scenario?
    1: Surrender and cash out
    2: Pay off loan monthly
    3: Choose NOT to pay off loan and have it deducted from the proceeds at my death

    Any Pros and Cons of the 3 choice would be appreciated.


  7. Kate4Kim@P4P says:

    Hi Erik, great question, I’m sure a few readers can relate!

    In your situation, we would recommend borrowing against it, pay the 8% which is probably fixed annually if possible, and then pay the principle back monthly. (The sooner the better, just to save on interest, but no need to stress.) Don’t simply withdraw (vs. borrowing against) or cash out policy, as you can no longer get the same protection at the same price.

    Borrowing (and paying pack) from your policy will work fine as you are young and the policy is established (more than 7 years.) If after 5 years or so you haven’t been able to pay back the policy loan for some reason, then you might need to re-evaluate at that time and consider cancelling it, as the interest from the loan will compromise the profitability and even the stability of the policy if interest costs continue to accrue and drain the policy. (UL Policies can “implode” and become worthless if costs drain the cash value, as we detail in “The Inconvenient Truth About the Other Permanent Insurance.”)

    You’re honestly too young to “wait until death benefit pays back the loan”… that will accrue way too much interest to work and it will implode the policy in time.

    Surrendering now does no good as you’ll start over 12 years older and with brand new costs. The least efficient years of a policy (as far as cash value go) are the first few years.

    Hope that helps! We also have an article with more detail on this topic: “Should You Borrow Against Your Cash Value or Withdraw It?” though understand that we are speaking here about whole life, rather than universal life.

  8. Erik says:

    Hi Kate4Kim,

    I couldn’t connect to your site earlier today. I got a database error when I tried to connect.

    I feel bad now that I didn’t see your post, because I went ahead and surrendered the policy. I tried to make the best decision I could from some sites I found on the internet, but it sounds like I didn’t make the right choice. I got worried about interest accruing.

    It’s a bummer because now my plan of $75.23 will according to State Farm jump (their best guess) to around $170/month in say 2 years or so. Does that sound right to you? Do you have any other suggestions for options on another policy?

    Thanks for the feedback; I wish I would have seen your post before I went and surrendered. I’m guessing since I did the electronic signature today that there is no way to back out of the decision now. Is that likely in your experience?

    Thanks again for your help,

  9. Kate4Kim@P4P says:

    We’re not sure if it was too late, but we advised Erik to contact his insurance agent, also to not cash any checks that came in the mail. Oftentimes you CAN cancel your cancellation!

  10. Ernest says:

    with a loan of $8500 dollars how much will an 8% interest rate cost me. It is figured different than banks

  11. P4P P4P says:


    $680 interest charged annually based on your policy anniversary date. Insurance companies calculate interest the same way banks do, but only bill for interest only.


  12. Deb says:

    We borrowed $8000.00 on our Met Life whole life insurance policy several years ago. We are just now in a position to be able to pay back the loan but our question is this in our best interest? Current cash value is $32,707.31 however the outstanding loan amount is $28,121.78. It has a guaranteed 4% interest rate yet they are charging us 7.40% interest on th loan. Our current monthly premium is $38.38. Policy holder is a 61 year old diabetic so we are not sure he would qualify for a new life insurance policy. Appreciate your assistance in making the best decision regarding keeping or terminating this current policy.

  13. Kate4Kim@P4P says:

    Great question, I believe Kim contacted you directly to get more information and address your question privately.

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