What are the advantages and disadvantages of a life insurance policy loan?

Nearly every cash value policy contract contains a policy loan provision that allows the policyholder to borrow the cash value. The cash value can't exceed the amount the policyholder has already paid towards the insurance policy in the form of premiums.

The difference between an actual loan and the life insurance policy loan is that the latter does not require repayment. Hence, a policy loan in life insurance does not in fact act as a "loan" per se, but rather as a pay advance that the policyholder takes out of the money they have already put in.

In addition, the insurer is permitted by state law to charge a variable policy loan interest rate. If the advance is not repaid during the policyholder's lifetime, the proceeds paid to the beneficiaries will be reduced by the amount borrowed plus the interest.

Life Insurance Policy Loan - Advantages

• The interest rate of policy loans is relatively low, typically amounting to 5-6% in older policies, and 8% in newer policies.
• It is not required to get the consent of either a revocable, or an irrevocable beneficiary for a policy loan. However, once the policy owner makes an absolute assignment to a third party beneficiary, the policy owner is not allowed to take any loans from the policy.
• No credit check is done.
• There is no fixed payment plan.
• The policyholder has the flexibility of deciding whether, when and how much to repay.

Disadvantages of Policy Loans in Life Insurance

• Because the policyholder is not required by law to repay the loan, they can let the policy lapse, in case the money borrowed exceeds the cash value.
• The policyholder may be tempted to surrender the policy for any remaining cash value, thus losing the security of owning life insurance.
• If the policy loan has not been repaid by the time the policyholder dies, the amount owed is deducted from the face amount, leaving the beneficiary with less funds than what they would have got otherwise.

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