Borrowing against your life insurance policy can be an attractive option when you need quick access to cash. However, understanding how soon you can do this and the implications of such a decision is crucial. This article explores the specifics of borrowing against a life insurance policy, focusing on the timeframe, process, and key considerations.
How Does Borrowing Money Against Life Insurance Work?
Borrowing against your life insurance policy is a financial option available primarily with whole life or universal life insurance policies. Here’s how the process works in Canada:
Building Cash Value
As you pay premiums for your whole or universal life insurance policy, a portion of those payments contributes to building a cash value. This cash value grows at an interest rate determined by the policy’s terms.
Using Cash Value as Collateral
Once enough cash value has accumulated, you can borrow against it. The loan is provided by the insurer, using your policy’s cash value as collateral.
Borrowing Process
- Application: Submit a form with your insurer.
- Approval: The insurer evaluates your policy’s cash value.
- Disbursement: Once approved, the loan amount is deposited into your account, typically within a few days.
How Soon Can I Borrow Against My Life Insurance Policy?
The ability to borrow against your life insurance policy depends on the accumulation of sufficient cash value. This timeframe can vary but generally requires at least a decade to build enough cash value.
Factors Influencing Cash Value Accumulation
- Policy Type: Whole life policies build cash value more predictably than universal life policies, which depend on market conditions.
- Premium Payments: Higher premium payments accelerate cash value growth.
- Interest Rates: Growth depends on the policy’s interest rate.
What is the Interest Rate on a Life Insurance Loan?
Interest rates for life insurance loans typically range between 5% and 8%. Whether the rate is fixed or variable impacts the overall cost of borrowing.
How Much Can You Borrow Against Your Life Insurance Policy?
Most insurers allow borrowing up to 90% of your policy’s cash value. The exact amount depends on the insurer’s guidelines and your accumulated cash value.
Do You Have to Pay Back Borrowed Money from Life Insurance?
Repaying a life insurance loan is not mandatory. However, unpaid loans accrue interest, leading to two possible outcomes:
- Reduction in Death Benefit: The insurer deducts the loan amount from the death benefit.
- Policy Lapse: If interest exceeds the cash value, your policy could lapse, resulting in loss of coverage.
Should You Borrow Against Your Life Insurance Policy?
Deciding whether to borrow against your life insurance policy depends on your financial situation and goals. Here are key considerations:
Pros
- Quick Access to Cash: Fast loan processing.
- No Credit Check: Borrowing doesn’t affect your credit score.
- Flexible Repayment: No fixed repayment schedule.
Cons
- Waiting Period: Requires years to build sufficient cash value.
- Risk of Losing Coverage: Unpaid loans can reduce the death benefit or cause policy lapse.
- Costly Policies: Whole and universal life policies are more expensive than term life insurance.
Advantages of Borrowing Against Your Life Insurance Policy
Quick Access to Cash
Life insurance loans provide quick funds without a lengthy approval process.
Doesn’t Affect Your Credit Score
Since the loan is secured by your policy’s cash value, there’s no credit check, and your credit score remains unaffected.
Flexibility in Repayment
There’s no fixed repayment schedule, offering flexibility. However, repaying promptly helps avoid accumulating interest.
Disadvantages of Borrowing Against Your Policy
Waiting for Cash Value to Build
Building sufficient cash value can take upwards of 10 years.
Risk of Losing Coverage
If the loan interest exceeds your policy’s cash value, your coverage could lapse or your death benefit may be reduced.
Limited to Whole or Universal Life Policies
Only whole or universal life policies allow borrowing, and these are more expensive than term policies.
Why You Should Consider Term Life Insurance Instead
For many Canadians, term life insurance is a more cost-effective option. While it doesn’t allow borrowing, the lower premiums enable savings or investment elsewhere.
Benefits of Term Life Insurance
- Lower Premiums: Significantly cheaper than whole or universal life policies.
- Simplicity: Straightforward coverage without cash value complexities.
- Flexibility: Savings from lower premiums can be invested in TFSAs or RRSPs.
Conclusion
Borrowing against your life insurance policy provides quick access to cash, but it’s essential to understand the implications and ensure it aligns with your financial goals. Carefully weigh the pros and cons, and consult a financial advisor to make an informed decision.