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Traditionally, life insurance policies were developed to financially protect the insured from death. The beneficiary of the insured would be offered a death benefit in the face of such an eventuality. However, in the latter part of the 20th century, life insurance products have evolved to take on a new purpose.
Several leading insurance companies today offer life insurance schemes that protect you from death and disabilities, and also yield investment benefits. Such insurance plans provide added benefits of policy loans that can be availed by policyholders at the time of a financial emergency.
A loan against your life insurance policy has several advantages over taking a personal loan or a credit card debt. But keep in mind that they are still loans that would have undesirable repercussions if you do not make timely repayments.
Do all life insurance plans offer policy loans?
According to the guidelines set down by the Insurance Regulatory and Development Authority of India (IRDA), unit linked insurance plans (ULIPs) do not offer policy loans. So, this facility is provided only by traditional non-linked endowment policies. The policyholder pays premiums for a specific duration towards the policy. After this time period of 3 years, the policy acquires surrender value. The loan amount that can be availed under the policy will be a percentage of this surrender value, say 60% to 80%.
It should be noted that term life insurance plans are pure protection plans and do not accumulate cash value. Hence, it would not be possible to borrow under such a policy as well.
So, if you are thinking of taking a loan under your life insurance, you should first assess whether the insurance provider offers this facility under the policy you have. This information will be present in the policy documentation, so reading it thoroughly will certainly help. Alternatively, you can visit the branch office of the insurance company and get the necessary details.
Your life insurance policy can also be used as a collateral for another loan, say a car loan. Consider a scenario in which you are buying a car with a downpayment for which you are falling short of funds. In this situation, you can request for assigning your life insurance policy to the bank from where you are taking the car loan.
Pros and cons of a life insurance policy loan
Taking a loan under your life insurance policy has its own set of advantages and disadvantages, as detailed below:
- As long as you have enough cash value under the life insurance policy, you can take a loan without any questions asked.
- Unlike bank loans, there is no stringent application process for a policy loan. You will just have to fill out a form and submit it to the insurer; you will receive the payment with minimal delays.
- Policy loans are availed under cash-value life insurance policies, i.e., the ones that offer you insurance benefits and savings. Hence, these do not appear on your credit report like ordinary credit card dues.
- Policy loans usually have lower interest rates than other types of debts.
- There is no rigid timetable for the repayment of a policy loan. If you do not repay the loan amount, it will be deducted from the death benefit under the policy.
- If you are borrowing an amount that is very small in comparison to your accumulated cash value and you have the means to pay back the loan within a definite time, then borrowing from your life insurance is a great option.
- You may take years to accumulate a significant cash value under your life insurance policy. So, a loan under it cannot be availed in the first few years.
- You will have to pay interests on policy loans, and this may seem insignificant at first. But if you do not make repayments, you will find that the cash value under the policy will start dwindling.
- If the sum of the policy loan and interest exceeds the cash value, the policy may move into lapsed status.
- There may be tax consequences for not paying back the loan amount.
Is it a good idea to borrow from your life insurance cash value?
As mentioned above, a loan against life insurance is an attractive alternative to a personal loan or a credit card debt that have sky-high interest rates. However, you should be careful when approaching your life insurer for a policy loan.
- Keep an eye on the interest accrued under the loan.
- Create a systematic schedule for yourself for loan repayment.
- Adhere to the set timelines and repay the loan in full, so that you can reap the expected benefits from the life insurance plan.
Although policy loans are easily available, it is not advisable to be dependent on it. As part of your financial planning, you should ideally have an amount equivalent to around 12 months of your monthly expenses in a liquid mutual fund or a fixed deposit account for use as a dedicated emergency fund. Policy loans should only be a last resort when the emergency fund has been depleted.
In conclusion, it is advisable to talk to a financial advisor before you actually take a policy loan. There may be several other ways in which you can meet your demands; so taking the assistance of an experienced professional will be immensely useful.