What is a Policy Loan? Everything You Need to Know

A policy loan is a type of loan you can take out against the cash value of your permanent life insurance policy. Essentially, you're borrowing from yourself, using your policy's accumulated cash value as collateral.

In this guide, you'll learn:

How policy loans work
The benefits of policy loans
The potential drawbacks of policy loans
Important considerations before taking a policy loan

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John Ramsey

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Updated on

June 30, 2024

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Glossary

Policy Loan

How Policy LoansWork

With a permanent life insurance policy, a portion of your premiums goes towards building cash value. This cash value grows tax-deferred over time. If your policy has sufficient cash value, you can borrow against it.

The loan amount you can borrow depends on your policy's cash value and any outstanding loans. Interest accrues on the loan balance, typically at a fixed rate. You can repay the loan in full at any time or make partial payments.

Benefits of Policy Loans

Accessibility: Policy loans are usually easy to obtain, with no credit checks or income verification required.
Flexibility: You can use the funds for any purpose, such as covering unexpected expenses, making investments, or consolidating debt.
No Repayment Schedule: There are no fixed repayment schedules, and you can repay the loan at your own pace.
Tax Advantages: Loan proceeds are generally not taxable, and interest payments may be tax-deductible in certain situations.

Potential Drawbacks of Policy Loans

Interest Accrual: Unpaid interest can accumulate and increase the loan balance, potentially eroding your policy's cash value.
Reduced Death Benefit: If the loan and accrued interest exceed the policy's cash value, the policy may lapse, leaving your beneficiaries with a reduced or no death benefit.
Tax Implications: If the policy lapses with an outstanding loan, the forgiven loan balance may be considered taxable income.

Important Considerations Before Taking a Policy Loan

Interest Rate: Understand the interest rate and how it may affect your policy's cash value over time.
Repayment Options: Be aware of the repayment options and potential consequences of not repaying the loan.
Impact on Death Benefit: Consider the impact of the loan on your policy's death benefit.
Alternatives: Explore alternative financing options, such as personal loans or lines of credit, to see if they might be more suitable.

If seeking a licensed professional, consider our services. Our insurance advisors and client support team are here to assist you with your insurance needs.

This guide has offered a comprehensive overview of policy loans. For those seeking to deepen their understanding, we recommend exploring our guide on permanent life insurance, which dives into the different types of permanent life insurance policies and their features in greater depth.

Policy Loan FAQ

What is a policy loan on a life insurance policy?

A policy loan is a loan you can take out against the cash value of your permanent life insurance policy. This means you're borrowing from yourself, using your policy's accumulated cash value as collateral.

How does a policy loan work with life insurance?

With a permanent life insurance policy, a portion of your premiums builds cash value. If your policy has enough cash value, you can borrow against it. The loan amount depends on your policy's cash value and any existing loans. Interest accrues, and you can repay the loan anytime or make partial payments.

What are the pros and cons of a policy loan?

Policy loans offer easy access to funds, flexible repayment, and potential tax advantages. However, unpaid interest can accumulate and erode your policy's cash value, potentially reducing the death benefit or even causing the policy to lapse.