When I help clients understand their life insurance options, one question that comes up frequently is whether they can borrow against their policy. The answer is yes—but it’s important to understand exactly how a life insurance policy loan works, what types of policies offer this feature, and what you should consider before taking one.
For a complete overview, see how the MPI strategy works.
Let me walk you through everything you need to know about policy loans so you can make an informed decision.
What Is a Life Insurance Policy Loan?
A life insurance policy loan allows you to borrow money from the insurance company using your policy’s cash value as collateral. This isn’t like a traditional bank loan where you’re borrowing the bank’s money—you’re essentially accessing your own accumulated cash value that’s built up inside your policy over time.
Here’s the key distinction: when you take a policy loan, you’re not actually withdrawing your cash value. Instead, the insurance company loans you money and places a lien against your cash value. Your cash value remains in the policy and continues to grow according to your policy’s terms.
Think of it like this—if your cash value is a bucket of water, a policy loan doesn’t take water out of the bucket. It just puts a claim against that bucket while the water stays put and continues to earn interest or dividends.
Which Types of Life Insurance Allow Policy Loans?
Not all life insurance policies offer the ability to take loans. Here’s what you need to know:
Policies That Allow Loans:
- Whole Life Insurance - These policies build cash value and typically allow loans after the first few years
- Universal Life Insurance - Flexible premium policies that accumulate cash value
- Indexed Universal Life (IUL) - Policies with cash value growth linked to market indices
- Variable Universal Life - Policies where cash value grows based on investment account performance
Policies That Don’t Allow Loans:
- Term Life Insurance - These policies provide pure insurance protection with no cash value component
How Life Insurance Policy Loans Work
When you take a life insurance policy loan, here’s what happens:
The Process
- You contact your insurance company and request a loan against your cash value
- The company evaluates how much you can borrow (typically 80-90% of your cash value)
- You receive the loan funds, usually within a few business days
- Your cash value stays in the policy and continues earning growth
- You pay interest on the borrowed amount
Interest Rates and Terms
Policy loan interest rates are typically lower than traditional loans—often ranging from 4% to 6%. The exact rate depends on your insurance company and policy terms, and it’s usually stated in your contract.
Unlike bank loans, there’s no required payment schedule. You can:
- Make regular interest payments
- Let the interest compound and add to your loan balance
- Pay back the principal whenever you want
- Never pay it back at all (though this affects your death benefit)
The Advantages of Life Insurance Policy Loans
I often explain to clients that policy loans offer several unique advantages:
No Credit Check Required
Since you’re borrowing against your own cash value, the insurance company doesn’t need to check your credit score or verify your income. The cash value serves as collateral.
Flexible Repayment
There’s no required monthly payment. You have complete flexibility in when and how much you repay. Some people make regular payments, others pay it back in a lump sum, and some choose never to repay it.
Tax Advantages
Policy loans are generally not treated as taxable income. This can be a significant advantage compared to withdrawing money from retirement accounts like 401(k)s or traditional IRAs.
Your Cash Value Keeps Growing
This is where it gets interesting—your full cash value amount typically continues to earn interest or dividends even while you have an outstanding loan. This means you could potentially earn more on your cash value than you’re paying in loan interest.
Quick Access to Funds
Most insurance companies can process policy loans within a few business days, making it a relatively quick source of cash when you need it.
Important Considerations and Potential Drawbacks
While policy loans can be valuable, I always make sure my clients understand the potential downsides:
Impact on Death Benefit
Any outstanding loan balance (plus accrued interest) will be deducted from your death benefit. If you borrowed $50,000 and never paid it back, your beneficiaries would receive $50,000 less than the original death benefit amount.
Policy Lapse Risk
If your loan balance grows too large relative to your cash value—especially if you’re not making payments and interest is compounding—your policy could lapse. This would terminate your coverage and could create a taxable event.
Opportunity Cost
While your cash value continues growing, you’re also paying loan interest. Depending on your policy’s performance and the loan rate, there could be a net cost to borrowing.
Surrender Charges May Apply
Some policies have surrender charges that apply if you cancel the policy. While this doesn’t directly affect loans, it’s something to consider if you’re thinking about accessing your cash value.
Smart Strategies for Using Policy Loans
In my experience, the most successful clients use policy loans strategically:
Emergency Fund Access
Having cash value you can borrow against creates a backup emergency fund that doesn’t affect your regular savings or require credit applications.
Investment Opportunities
Some clients use policy loans to fund investment opportunities when they don’t want to liquidate other investments or when market timing is a consideration.
Retirement Income Strategy
For properly designed policies, loans can be part of a tax-advantaged retirement income strategy. This is particularly relevant with max-funded universal life policies where the loan feature becomes central to the retirement income plan.
Major Purchases
Policy loans can fund major purchases like home improvements, education expenses, or business investments while keeping your cash value working for you.
The MPI Strategy and Policy Loans
One advanced approach I help clients understand is how policy loans work within the MPI (Maximum Premium Indexing) strategy. This involves using a properly designed, max-funded indexed universal life policy where the participating loan feature becomes a key component of the wealth-building strategy.
With the MPI strategy, clients can potentially:
- Take loans against their cash value
- Re-contribute those funds as additional premiums
- Have both their original cash value AND the borrowed funds earning index-linked growth
- Create a positive spread when growth exceeds loan interest rates
This approach requires careful design and understanding, but it can potentially amplify the compound growth within the policy.
Is a Life Insurance Policy Loan Right for You?
Whether a policy loan makes sense depends on your specific situation. Here are some questions I encourage clients to consider:
- Do you have adequate cash value built up in your policy?
- Are you comfortable with the impact on your death benefit?
- Do you have a plan for managing the loan (even if it’s to never repay it)?
- Are you using the loan strategically as part of a broader financial plan?
- Do you understand your policy’s terms regarding loans and potential lapse scenarios?
Working with a Professional
Life insurance policy loans can be powerful financial tools, but they require understanding your specific policy terms and how loans fit into your overall financial picture. Every policy is different, and what works for one person may not be appropriate for another.
I work with clients to help them understand their existing policies or design new ones that align with their goals. Whether you’re looking at policy loans for emergency access, strategic wealth building, or retirement income planning, having a clear understanding of the mechanics and implications is essential.
Finding the Right Coverage
If you don’t currently have a life insurance policy with cash value, or if you’re wondering whether your existing coverage offers the features you need, I can help you explore your options. As an independent agent, I work with multiple top-rated carriers and can help you compare policies to find coverage that fits your needs and goals.
Related Reading
- Policy Loan Life Insurance: What You Should Know
- Retirement Income Solutions: What You Should Know
- Benefits of IUL: What You Should Know
- MPI Investment: What You Should Know
Ready to explore your life insurance options? I’ll help you understand how different policies work, what loan features are available, and how they might fit into your financial strategy.
Get Your Free Quote Comparison
- Borrow against permanent life insurance policies like whole life or universal life using your accumulated cash value as collateral, while your money stays in the policy and continues growing.
- Expect lower interest rates than traditional loans (typically 4-6%) with no credit checks required since you’re borrowing against your own cash value.
- Enjoy flexible repayment terms with no required payment schedule - you can pay interest only, let it compound, or repay whenever you choose.
- Understand that unpaid loan balances plus interest will reduce your death benefit dollar-for-dollar if not repaid before you pass away.
- Consider policy loans for emergency funds or major expenses when you need quick access to cash without the strict requirements of conventional bank lending.
