You may have seen commercials on TV that show how people are borrowing on their life insurance policies and reaping the rewards of having more money today. This is a growing trend when it comes to lending practices as it is focused on something you own with real value, but normally cannot be tapped until you are ready to cash out the policy.
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The acts of borrowing from life insurance cash value may be a rather common tactic today, but is it something that you really need to do? Before you answer that question, it is important to understand what is cash value, do you have the right type of life insurance policy, and what are the advantages of borrowing?
What is Life Insurance Cash Value?
In purchasing whole life insurance, the amount that is overpaid in the early years of the policy is set aside and called the “cash value”. Basically, in the first several years of the policy’s existence, the insurance company may assess what is known as “surrender charges” which will allow them to recover the commissions on sales and any related cost as well.
The difference between the cash value of the policy and the surrender charges is called the “surrender value”. This is the value that can be borrowed against for the purposes of making a loan. The surrender or loan value is what lenders use in judging just how much can be borrowed against the policy itself.
Can I really Borrow from Life Insurance?
The answer is “yes” you can borrow from the cash value of your life insurance policy. However, there are two conditions to whether you can borrow from your policy or not;
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- It must be whole life insurance.
- It can only be up to the amount of the cash surrender value.
This means that if you have term life insurance, you cannot borrow against it because it has no cash surrender value. Plus, if want you want to borrow exceeds the current surrender value, then you will need to find another source in order to make up the difference.
The Advantages and Disadvantages of Borrowing from Your Life Insurance Policy:
There are a number of elements that you will need to consider when borrowing against life insurance cash value. This is especially important if you have other options to raise the capital that you need.
Secure: The cash value of the life insurance can be seen as solid collateral that lenders are normally comfortable with. This means that unlike assets such as vehicles for example that must be re-sold in order to get back the cash, the value of the life insurance policy can be used almost immediately. This means that lenders are far more comfortable with making this particular type of deal with their customers.
Future Assets: Unlike traditional borrowing which uses either unsecured or secured resources, the cash surrender value is not an asset that people use on a daily basis. For example, if you fail to pay off your credit cards, your credit score is dropped. If you use your vehicle as collateral and you fail to pay off the loan, the car or truck is repossessed. However, the cash surrender value of your life insurance policy is something that you are not currently using which means that whatever happens you still have your other assets at work.
Quick: This type of borrowing against whole life insurance has become a common practice and can be done rather quickly. There are many lenders who will have the proper forms and will be ready to make such a loan even if your credit score is low or in deep trouble. This is because you already have the secured capital to repay the money that is being borrowed.
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While this form of lending is quite common, it does come with some disadvantages that you will need to be aware of before you choose to enter into this type of agreement.
Reduced Benefits: If you should pass away unexpectedly after borrowing from the policy, the lender will be able to recoup their money through the benefits that are paid. This may mean that your life insurance policy will no longer be able to cover all the expenses and debts which will put a financial burden on your family.
Additional Debt Burden: Taking on more debt is something that most people want to avoid. Even though the money is secure, generally speaking, it is better to find another method of getting the money you need other than borrowing. It may be that you really will need the full value of your life insurance policy in case the worst should occur. This is especially true when you consider the interest that has to be paid on the loan itself.
Easier to Cash Out the Policy: If you do not really need the life insurance policy, then you probably would be better off cashing it out for the surrender value and not having to deal with a lender. This should only be done if you have coverage that more than makes up for the life insurance policy that you no longer need.
There are other options that you can take as well if you are in need of immediate capital. However, it is generally best to try and avoid such situations if at all possible by planning ahead by saving your money so that if an unexpected financial crisis should arise you can pay for it immediately. While this may seem impractical to some, the truth is that most savings are done a few dollars at a time. After a few years, the amount of money put back may be considerable and more than enough to cover unexpected medical, vehicular repair, or other expenses that pop up.
When you borrow from life insurance, it is a tradeoff that has both positive and negative aspects. However, it is an option that may be exercised if it is the best choice to get out of a financially difficult situation.