Should You Borrow from Life Insurance to Pay Off Debt?

Borrowing from Life Insurance to Consolidate Debt

Couple contemplating borrowing from life insurance policyWhen was the last time you considered your life insurance policy as a bailout for credit card debt?

“WHAT?” Use an insurance policy to pay off credit card debt?

Yes, it can be done. If you have the right type of life insurance – whole life or universal life – and have been making on-time payments to it for an extended period, you may have accrued enough “cash value” in the policy to bury your credit card debt.

Let’s say you have $15,000 in credit card debt and can’t qualify for a debt management program from a nonprofit credit counseling agency or don’t have a good enough credit score to get a loan from a bank.

But you do have a $100,000 life insurance policy you’ve been paying on for 25 years and it has a cash value of $20,000. You could borrow a significant portion of the $20,000 cash value, wipe out the credit card debt and pay yourself back over time.

Or not pay yourself back!

Yes, one of the many positives of borrowing against a life insurance policy is that you only have to pay the interest on the loan every year. You do not have to pay back the principle.

Now before you get too excited, understand that not all life insurance policies are the same and there are conditions for both the policy and borrowing against it that have to be met to successfully execute this form of debt consolidation, but it can be done.

How to Borrow from 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.

Start by calling your insurance agent, or the 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 is 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.

Next, ask the agent/representative to email you a “Policy Loan Request.” This is a standard form that asks contact information (name, address, social security number, etc.) and how much of the cash value you want to borrow from your policy.

Fill it out, sign it, return it and a check for the requested amount is sent to your mailing address in 7-10 business days.

There is no application fee, no credit check and no answering questions from a loan officer as to 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.

The truth is that a majority of consumers have term life insurance because it is considerably cheaper, but it has no cash value so you can’t borrow against 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. That cash value should be part of your annual statement from the insurer. If you are not confident 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.

Pros and Cons of Borrowing Against Your Life Insurance

Every consumer should investigate and weigh the positives and negatives of economic decisions, including whether it’s smart to take a loan out against your 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 for 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. There is a requirement to pay the annual interest on the loan, but no requirement that you pay back the principle. However, be aware that if you don’t repay it, the unpaid portion of the loan and interest will be deducted 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.
  • No impact on your credit score. Payments (or missed payments) are not reported to credit bureaus.
  • The interest rate on life insurance loans usually is considerably less than what is 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 Against Borrowing from Life Insurance

  • It may not be available with your life insurance policy. The majority of 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 of time. There is no clear definition of what “extended” means, but it’s safe to say that you probably need to pay at least 10-20 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 in the form of 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 impacted.

Should I Take Out a Loan Against My Life Insurance Policy?

It’s impossible to throw a blanket over every individual’s financial circumstances 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.

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

However, if you’re barely breathing under $10,000-$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?


Sources

NA. (2018, September 4) New Study Reveals More Than 40 Percent of Americans Don’t Have Any Form of Life Insurance. Retrieved from https://www.marketwatch.com/press-release/new-study-reveals-more-than-40-percent-of-americans-dont-have-any-form-of-life-insurance-2018-09-04

NA. (2018, March 21) How & Why To request An Inforce Life Insurance Illustration. Retrieved from https://www.pacificinsurancegroup.com/how-why-to-request-an-inforce-life-insurance-illustration/