Understanding Policy Loans on Life Insurance

A policy loan on life insurance is a borrowing option that lets a policyholder use the cash value built up in a permanent life insurance policy as collateral. The loan is typically taken against the policy's accumulated cash value, not against the death benefit, and the policy remains in force as long as the loan is repaid with interest.

How Policy Loans Work

Permanent policies such as whole life or universal life accumulate cash value over time. Policyholders may request a loan through their insurer, receiving a cash amount up to a percentage of that value—often 80% or 90%. The loan accrues interest at a rate set by the insurer, usually lower than conventional loans but still payable over time. If the loan balance plus interest exceeds the cash value, the policy's death benefit is reduced accordingly, and the policy may lapse if not enough value remains to cover the loan.

Interest and Repayment

Interest on a policy loan is typically compounded annually. If the policyholder does not make repayments, the interest is added to the loan balance, increasing the amount owed. Repayments can be made at any time, and they reduce the principal and the interest owed. Policy loans are not taxed as long as the policy remains in force; however, unpaid interest may be treated as a taxable event if the policy lapses.

Benefits and Risks

Benefits include flexible access to funds without credit checks, and the ability to use the money for emergencies, investments, or debt consolidation. Because the loan is collateralized by the policy's cash value, it is often cheaper and faster than bank loans. Risks involve the potential reduction of the death benefit, the possibility of policy lapse if the loan grows too large, and the compounding interest that can erode the policy's value over time.

When to Consider a Policy Loan

Policy loans are useful when a policyholder needs liquidity, wants to avoid selling assets, or seeks a low‑interest borrowing option. They should be considered carefully when the policy's cash value is sufficient to cover the loan plus interest, and when the policyholder plans to repay the loan to preserve the death benefit.