Borrowing Against Life Insurance to Pay Off Debt

If you have a certain kind of life insurance – whole life or universal life – your policy may have enough value to help you eliminate your credit card debt.

For this to work, you must have been making on-time payments for an extended period, long enough to accumulate significant cash value. For example, if you have a $100,000 life insurance policy that you’ve been paying on for 25 years, it may have a cash value of $20,000. In that case, you could borrow a significant portion of that $20,000 value and use the money to wipe out your credit card debt.

This strategy is one to consider if you don’t qualify for a debt management program with a nonprofit credit counseling agency or don’t have a good enough credit score to get a loan from a bank. Before you get too excited, understand that not all life insurance policies are the same and that you must meet some conditions for both the policy and borrowing against it to execute this form of debt consolidation.

How to Borrow Against Life Insurance

The process of borrowing from life insurance is so simple that if you have a phone and an internet connection, you could do the whole thing in a morning.

1. Start by calling your insurance agent. This could also be the insurance company you bought the policy from to confirm that your policy is a cash-value policy, e.g. whole life or universal life.

If that’s the case, ask the agent/representative to email you an “in-force illustration,” which is a statement that tells you the cash value of your policy and what it’s projected to do down the road. This will tell you how much you can borrow against your policy.

2. Ask the agent/representative to email you a “Policy Loan Request.” This is a standard form, which asks for specific contact information (name, address, social security number, etc.) and how much of the cash value you want to borrow from your policy.
3. Fill it out, sign it and return it. Within seven to 10 business days, the company will send you a check for the requested amount.

There is no application fee, no credit check and no answering questions from a loan officer about what the funds are going for.

What Types of Life Insurance Policies Can You Borrow From?

Consumers can only borrow from cash-value polices, better known as whole life or universal life.

Most consumers have term life insurance because it is considerably cheaper, but it has no cash value, so you can’t borrow against it.

» Learn More: Is Life Insurance Worth It?

How Much Can You Borrow from Life Insurance?

It’s possible to borrow a significant portion of the cash value of your life insurance policy. You can learn the cash value of your policy on the annual statement from the insurer. If you’re not sure you have the correct current value, call your agent or a customer service representative, give them your policy number and they can give you an accurate answer.

When Can You Borrow from Life Insurance?

You can borrow against your policy as soon as you accumulate a cash value. If you pay for the policy monthly, your borrow date will come after a few months. If you pay for it annually, your borrow date will come after that first year.

However, the longer you own the policy (without borrowing against it), the more value it will hold – and the more you can borrow. Also, different policies can build up their cash value faster than others. Your insurance company can provide you with a long-term schedule of cash value buildup.

Many – and maybe most – life insurance policies have guidelines about borrowing against the policy. First, it must contain a borrowing provision for you to borrow from the cash value. Many insurers also allow you to borrow only up to 90% of the cash value.

So, if you have $50,000 in cash value, you could borrow up to $45,000.

Pros and Cons of Borrowing Against Your Life Insurance

Every consumer should weigh the positives and negatives of economic decisions, including whether it’s smart to take a loan out against their life insurance policy.

Every consumer’s financial situation is unique to themselves and their families and should be treated that way. One size does not fit all, and that certainly is the case here. Weigh the pros and cons with your needs and long-term plans before deciding.

Pros of Borrowing from Life Insurance

• The most obvious is that you’re borrowing from yourself … and paying yourself back yourself.
• You can use the money for anything you want. You can pay off credit card debt or any other purpose without having to explain yourself.
• You don’t have to pay the loan back. You must pay the annual interest on the loan, but you have no requirement to pay back the principal. However, if you don’t repay the loan, the insurer will deduct the unpaid portion of the loan and interest from the death benefit.
• Credit scores don’t matter. There is no examination of your credit report. No application fees or costs deducted for taking out the loan.
• The loan has no impact on your credit score. Payments (or missed payments) are not reported to credit bureaus.
• The interest rate on life insurance loans is usually considerably less than what you would get charged for a credit card and should be less than what you would pay on a consolidation loan. If you have been paying on the insurance policy for more than 10 years, you could get an interest rate under 4%.

Cons of Borrowing from Life Insurance

• It may not be available with your life insurance policy. Most consumers own “term life” insurance, which does not have a cash value aspect to it and thus would not be available to borrow against.
• You must make payments on the insurance policy for an extended period. There is no clear definition of what “extended” means, but it’s safe to say that you probably need to pay at least 10 to 20 years of premiums. The longer, the better.
• You will lose some of your death benefits if you don’t repay the loan.
• You must be the policy owner. You can’t be the brother or sister or wife who does the borrowing.
• Life insurance benefits are protected from creditors unless you take out the cash value as a loan.

Tax Implications of Borrowing from Life Insurance

It is unlikely you will have tax implications for taking a loan out against your insurance policy, but there is something that borrowers should be mindful of.

If, for any reason, there is not enough cash value and/or premiums and the policy lapses, you could have a taxable event. That is extremely unlikely but always check with your financial adviser to find out if you could be affected.

Should I Borrow Against My Life Insurance to Pay Off Debt?

It’s impossible to throw a blanket over every individual’s financial circumstance and say yes or no to that question. It is always prudent to seek advice from a financial adviser, your insurance agent or a credit counselor before making a final decision.

When It Makes Sense: The truth is that the situation described above regarding tax implications – your cash value exceeds the amount you paid in premiums – is extremely rare.

When It Doesn’t Make Sense: However, if you’re barely breathing under $10,000 to $20,000 of credit card debt and have a well-funded life insurance policy that gives you a chance to come up for air … why wouldn’t you do it?