Everything You Wanted to Know About Borrowing From a Life Insurance Policy

Life insurance started thousands of years ago as a way for Ancient Romans to have money to bury the dead, and over the centuries it has matured into a powerful wealth-building tool whose capabilities go far beyond what the Romans could have imagined.

Much of the power and flexibility of modern life insurance products come from the cash value that can build up inside a permanent life insurance policy.

Cash value is that portion of the money in your life insurance policy you can use before you pass away. Nobody has to die for you to take advantage of your life insurance policy’s living benefits!

Here are some of the questions people ask about life insurance policy loans:

Can You Borrow Against a Term Life Insurance Policy?

Generally, no, you can’t borrow against a term policy. That’s because typical term life insurance policies don’t build any cash value. Borrowing from a life insurance policy works because the insurance company uses your cash value as collateral for the loan. With no cash value in a term policy, it’s not possible to take out a loan against it.

On the other hand, one of the safest types of life insurance to borrow from is a whole life policy, for reasons we’ll share in a few minutes.

Can You Borrow from Life Insurance Policies Other Than Whole Life Insurance?

Yes. You can borrow against any permanent life insurance policy. Permanent life insurance policies all build up cash value. Whole life, universal life, indexed universal life, variable life, and variable universal life are all examples of permanent life insurance policies.

Later in this article, we’ll explain why taking loans against some of these policies can cause costly problems for you.

How Much Can I Borrow from My Permanent Life Insurance Policy?

You’re technically not borrowing from your policy. You’re borrowing from the life insurance company’s general fund and using your cash value and death benefit as collateral. You can typically take a loan against 85% – 90% of your cash value, depending on what the issuing life insurance company allows.

For more information, check out this article from our No-Nonsense Consumer Guide to Life Insurance: “How Do Life Insurance Loans Work and Is One Right For You?”

How Soon Can I Borrow from My Life Insurance Policy?

You can borrow as soon as you’ve built up a little cash value. With whole life policies, it may take several years to build up anything beyond negligible cash value. However, with high-early-cash-value dividend-paying whole life insurance such as “Bank On Yourself-type” policies, you’ll typically have cash value you can borrow against within the first month!

That doesn’t mean that borrowing against your policy so soon is necessarily a good idea, but it would be an option available to you if your circumstances warrant it.

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How Do Life Insurance Loans Work?

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Here’s a quick overview of how life insurance policy loans work:

  1. You tell the company how much you want to borrow (up to the applicable limit) and where to send the money. You don’t have to fill out any nosey credit applications or even explain why you want the money.
  2. The company sends you a check or wire transfer within a few days.
  3. The company will charge you interest (normally at a very competitive rate – after all, they have your policy as collateral), which is added to your loan balance.
  4. If your policy is from one of the handful of companies that offers this feature, you’ll continue to earn the exact same growth in your policy as you would if you hadn’t taken a policy loan. And if you pay your loans back at the interest rate the company charges, you will end up with the exact same cash value you’d have if you didn’t use your policy to finance things!

    For example, let’s say that at the end of Year 25, your policy is projected to have $400,000 of cash value – if you haven’t borrowed against the policy. But let’s say that in Year 5 you did borrow, to buy a car. And then let’s assume you paid back the loan at the interest rate the company charged, over the next five years. At the end of Year 25, your cash value would still be $400,000 – the same as if you hadn’t borrowed against it to purchase anything.

    What if you borrowed and repaid more than once? What if you did it four, five, or dozens of times? As long as you pay back the loan at the interest rate the company charges, your cash value will still be the same as if you hadn’t borrowed.

    Is that cool, or what?

    But do not assume you can do this with your life insurance policy. Only a handful of life insurance companies offer this feature. That’s one reason to be working with one of the 200 Bank On Yourself Authorized Advisors.

  5. You do not have a required repayment schedule. You may make payments when you like, in the amounts you like. Just remember that the outstanding balance accrues interest.
  6. When the insured passes away, any outstanding loan balance will be paid off (deducted) from the death benefit, with the remaining death benefit going to the policy’s beneficiaries.

For more information, check out the article from our No-Nonsense Consumer Guide to Life Insurance: “How Bank On Yourself Whole Life Insurance Policy Loans Work”

Should I Pay off My Life Insurance Loan?

In general, yes. While you aren’t tied to a rigid repayment schedule, paying off your loan in reasonable fashion has three important benefits for you:

  1. It makes the money available for other needs. (For example, paying off loans earmarked for college expenses can allow you to access the money in retirement.)
  2. If you pass away with a policy loan outstanding, the death benefit paid to your beneficiaries will be reduced by the amount of the outstanding loan.
  3. If the loan balance reaches the amount of the cash value, your policy could lapse, with dire tax consequences.

So in general, it’s wise to repay your loans. However, most people – if they’re borrowing to help meet expenses in retirement – do not plan to repay their loans after they’ve stopped working.

Your advisor can help you determine the wisest path for you, even before you take out a policy.

There Is Something You Need to Be Aware of with a Life Insurance Policy Loan

The outstanding balance on a policy loan that’s taken and forgotten will grow over time and could become significant, as unpaid loan interest is added to the outstanding balance.

Thankfully, it’s easy to avoid this unfortunate possibility. A Bank On Yourself Authorized Advisor is trained to monitor your loans annually to be sure your outstanding loan balance is well below your total cash value. If necessary, he or she may recommend that you at least pay the interest on your policy loan.

Some Types of Life Insurance Policies Are Much Safer to Borrow Against Than Others

Remember that we said it’s possible to borrow from any policy that builds cash value? That’s true. But with some policy types, you could be playing with fire. When you’re considering taking out a life insurance policy loan against your existing policy, remember the following for your own financial safety and peace of mind:

Universal life and indexed universal insurance policy loan concerns

The costs for insurance and administrative charges in universal life (UL) and indexed universal life (IUL) policies are deducted from the policy’s cash values every month. These costs can include insurance charges, policy charges, transaction charges, policy issue charges, premium charges, and costs for additional riders.

And UL and IUL insurance contracts state that when those costs go up, the company can pass the increases on to you, the policyowner, up to some maximum limit. This can cause your cash value to go down, endangering your policy.

Increased costs can also lead the company to increase your premium. If your premium goes up, you’ll have less cash to pay down your loan, which could cause your loan balance to go up.

There’s another problem that sneaks up on unsuspecting IUL policy owners. It’s when one of the “good” things promoted by universal life salespeople turns out to be a “really bad” thing.

Here’s the “good” thing, and it’s often used as a selling point for IUL policies:

Most IUL policies issued in the last few years offer “non-direct recognition loans.” This simply means that if you have a loan against one of these policies, that loan does not change the crediting rate on your cash value. That is a good feature, and it’s one that “Bank On Yourself-type” whole life policies generally offer.

But it can turn bad, because IUL salespeople often imply that their policies will grow at an unrealistically high rate, often 8% annually – or more. (Several life insurance companies offering IUL policies have been sued by the government over this very issue.)

If you have a policy where you’ll only be charged 6% interest for a loan and you’ve been led to believe you’ll be earning 8% or more, you’d be money ahead to take every dime you could out of the policy and reinvest it, wouldn’t you?

But no IUL policy has ever returned 8% annually over the life of the policy. Some years, there’s been no growth at all!

If you had borrowed 50% of your cash value and in six out of ten years there was no gain in the policy (and this has happened before), you could reduce your policy’s value by 40% if the loan isn’t repaid. Suddenly you have a policy with less cash value than expected while at the same time, you have a huge loan.

Your policy will likely lapse unless you have the resources to pay down the loan to keep the balance from approaching the cash value.

In a case like this, could you just cancel your policy to save your bacon? Unfortunately, no.

Why not?

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Because the moment you cancel your policy, you’ll owe income tax on every penny you received from the cash value of your policy that’s beyond the premiums you paid.

Here’s a real-life example:

John had a life insurance policy with a cash value of $400,000. He has paid $100,000 in premiums up until now, and he has borrowed heavily against his policy. In fact, John owes $360,000 on his policy loan.

If John cancels his policy – or if the insurance company cancels it to pay off his loan – the amount John will have to claim as income on his taxes just from this one transaction is $300,000 ($400,000 cash value minus the $100,000 he paid in premiums).

According to the Tax Foundation, that would put John in the 32% tax bracket. That’s $96,000 in taxes on a policy he just cancelled because his loan balance had wiped out his cash value, and he couldn’t afford to pay down his loan balance.

If John can’t afford to pay down his loan balance even a little, where in the world will he get the money to pay the IRS???

Variable life and universal variable insurance policy loan concerns

The concerns with variable life insurance policy loans are similar to those with universal policies. The death benefit or the cash value may shrink, rather than grow. Premiums may be increased. There is no guarantee this won’t happen.

With any policy whose basic components are not all guaranteed, borrowing – with or without a plan to repay the loan – is quite risky, because the policy’s future performance is unknown and unknowable.

If your policy performs poorly, you personally will have to deal with the results: higher premiums, lower death benefit, and shrinking cash value – which, coupled with a large loan balance, could cause your policy to lapse, possibly triggering a staggering tax bill.

This could be a very serious problem, because having used your cash value to pay off the loan, you won’t have any remaining cash value to pay the tax bill that comes from this “phantom income.”

Summing Up: The Problem with Universal and Variable Life Insurance Policy Loans in One Sentence

These policies have many moving parts, but there is no guarantee the parts will all move in a direction that is favorable to you – and that could be your downfall.

Why whole life insurance policy loans are safer

With a whole life policy, all those costs that UL and IUL policyowners have passed on to them are already accounted for and factored into your premiums.

As a policyholder, you won’t have any unhappy surprises, because everything is guaranteed. That means your annual cash value increases, your death benefit, and the premiums you pay are all locked in. And with a dividend-paying whole life insurance policy, everything is guaranteed except the dividends.

Dividends can only make your situation better, not worse!


The benefit to you is that you know in advance what your minimum cash value will be at any given time. There’s no possibility that your cash value will go below that level, triggering a possible unforeseen policy lapse.

Consider Making a “Bank On Yourself-Type” Dividend-Paying Whole Life Insurance Policy Part of Your Financial Plan

You don’t buy a life insurance policy solely for it’s living benefits, of course. You buy it to protect your family and the organizations you care about against financial losses if you die prematurely.

But you should not ignore the living benefits of a “Bank On Yourself-type” whole life insurance policy! One of those living benefits is the ability to safely borrow against your policy to finance major purchases, while your policy grows as if you hadn’t touched it.

There are other benefits as well, including tax advantages, security, and guaranteed growth.

To learn more about the Bank On Yourself strategy and the benefits it can give you, download your copy of our FREE Special Report, 5 Simple Steps to Bypass Wall Street, Beat the Banks at Their Own Game and Take Control of Your Financial Future.

And to find out if a high-early-cash value dividend-paying “Bank On Yourself-type” whole life insurance policy makes sense for your situation, request a free Analysis and Recommendations from a qualified and highly-trained Bank On Yourself Authorized Advisor. There is no obligation.

Not only will you find out what you could gain with such a policy, you’ll also discover how much you stand to lose by not taking advantage of this powerful wealth-building tool:

Continue to the Table of Contents for the No-Nonsense Life Insurance Guide