Many people consider borrowing against their life insurance policy for numerous reasons. The question is when the proper timing is and what are the considerations involved in such a decision.
Typically, during the first ten years that a life insurance policy is in force, the funds accumulated are not enough to cover for major needs, unless the policyholder has been over-funding the policy for that particular purpose. After the first ten years are through, considering borrowing against life insurance policy is a good decision, for the most part, because interest rates are typically very low and repayment may be deferred over a long period. Whether whole or permanent, life insurance policy may accrue a cash value that can be used any time by the policyholder.
The first step is to determine the cash value of the insurance policy, which can be found on monthly statements. Usually, people borrow up to 90 percent of the cash value to cover for their needs. The good thing is that, once the money is borrowed the policyholder has the right to repay or not the loan. If the loan is not repaid it is simply deducted from the cash value of the policy. To illustrate this better, we assume that a policyholder has a life insurance policy of $40,000 and before dying he had withdrawn $5,000. Therefore, the payable death benefit for the beneficiaries of the life insurance policy would be $35,000. If, instead, the policyholder would have chosen to pay back the loan, the amount would be $5,000 plus the interest rate. Although interest rates are significantly lower than any other sources, there might be some unexpected fees associated that will probably increase the base rate.
Interest rates are very important in a policyholder’s decision to borrow against a life insurance policy. Normally, life insurance companies earn interest on their investments. When policyholders decide to borrow against their life insurance policies, the amount that is invested is reduced by the loan amounts, which consequently reduces the interest earned on the investment. This explains why the interest rates on insurance policy loans are low, unless life insurance companies charge higher interest by default to cover up for the losses.
Generally, there are few regulations governing borrowing against life insurance policy. Some insurance companies may require higher premiums after a loan has been processed or a viatical settlement that would guarantee that any unpaid balance and loan interest would be deducted from the policy amount upon the policyholder’s untimely and unexpected death. But, in general, a life insurance policy is money that the policyholder has paid taxes on, there are no age restrictions and, most importantly, no penalty, if the policyholder decides not to repay the loan.
The best thing to do is to take the advice of an insurance professional before borrowing against a life insurance policy. There are cases that a home equity loan may be a better option for it accrues less interest. It’s all a matter of timing and proper evaluation of the market factors.