Should You Take A Loan Against Your Insurance Policy?

There are various credit options available, but for each conditions apply. Income level, documents, source of income, etc., all play a role in whether a person gets the loan from the usual sources or not. Many people don’t fulfil these criteria, and, therefore, have to turn elsewhere for credit. One of the alternate sources is loan on insurance policy. 

What Is Loan Against Insurance Policy?

“A loan against an insurance policy is a form of loan against security where you can pledge some form of a financial asset, which in this case is your insurance policy, for which the lender will grant you a loan, quite similar to a loan against property,” says V Swaminathan, CEO, Andromeda.  

If you have paid the premiums for three consecutive years without missing a payment, you may be able to obtain a loan for up to 90 per cent of the surrender value of your policy. Furthermore, these loans are only available to policyholders of endowment, whole life and money-back policies. They are not available to those who have term plans or unit-linked insurance policies. 

“In case of a loan against an insurance policy, additional collateral/asset is not required as the insurance policy itself acts as a guarantee. Also, the interest rate on this type of loan is normally lesser than on a personal loan,” says Arijit Sen, a Sebi-registered investment advisor and co-founder of Merry Mind, a Kolkata-based financial advisory firm.  

Compared to personal loans, which have high interest rates of 15-18 per cent, and credit card debt, which has interest rates in the range of 36-52 per cent, loans against insurance policies have lower interest rates, of 9-12 per cent. “The best part is that because it is an advance paid against the policy's maturity proceeds, the insurance companies do not consider creditworthiness or the CIBIL score when granting you this loan. When applying for a loan, income documentation and bank statements, in addition to the original policy documents, are required to be submitted,” says Swaminathan.  

Therefore, such loans work well for people who do not have enough documents to avail loans from banks or other lenders, or their credit scores are low and they cannot get loans at reasonable interest rates. “The facility to adjust the sum borrowed in the maturity proceeds could also be attractive for some, especially if their financial condition is stressed,” says Suresh Sadagopan, founder and principal of Ladder7 Financial Advisories, a financial planning firm.   

Hazards Of Loan Against Insurance Policy  

“When taking out a loan against a life insurance policy, one should proceed with prudence because the policy is intended to protect the policyholder's family in case of the policyholder’s death. If one chooses to pay back only the interest component, and the policyholder dies during the loan term, the pending amount due from the loan will be subtracted from the claim amount. Only the remaining money will be paid to the nominee,” says Swaminathan.  

It is important to remember that if the policyholder passes away unexpectedly before the debt is repaid, his or her family will not be the only beneficiaries of the insurance policy. A loan taken on the insurance may prevent the nominees from receiving the full benefit of the policy. 

If you cannot repay the loan secured by your life insurance policy, the interest will continue to accrue on the outstanding sum. If the loan amount becomes greater than the insurance policy's cash value, the coverage may be deemed invalid and terminated. In this case, the insurer will have the authority to recover the loan amount and interest from the surrender value of your policy and cancel the insurance coverage. 

Keep In Mind  

To make the best of this option, choose carefully. Avoid taking out a loan on your insurance in the initial years of the policy as the loan amount available to you would be smaller. Once you’ve paid a sufficient amount as premium for a few years, your loan eligible amount will be much higher. “Also, note that there will be a waiting period of 3 years after you’ve taken a policy to apply for a loan,” says Swaminathan.