In India, life insurance is not just viewed as a financial safeguard for breadwinners but also as an important component of one’s financial planning. However, a lesser-known feature of certain life insurance policies in India is the ability to borrow money against the policy itself. This feature can be a financial boon during times of need, and here we explore how it works.
Understanding the basics
In India, the types of life insurance policies that allow you to borrow against them are typically permanent life insurance policies, such as whole life and universal life insurance. Unlike term insurance, these policies have a cash value component along with the death benefit, which grows over time and can be used as collateral for a loan.
How to borrow from your life insurance policy
Borrowing against your life insurance policy in India involves a few straightforward steps:
- Assess your policy’s cash value: Ensure your policy has accumulated a sufficient cash value, which you can check on your insurance statement or by using a life insurance calculator provided by your insurer.
- Understand loan terms: Familiarise yourself with the specific terms of borrowing, including interest rates and repayment terms. This information is crucial for making an informed decision.
- Initiate the loan process: Contact your insurer to express your interest in taking out a loan against your policy. This process is usually straightforward, requiring minimal documentation, with no credit check involved since the loan is secured by your policy’s cash value.
Key considerations
When contemplating a loan against your life insurance policy, keep these factors in mind:
Interest Rates
- Accumulation and impact: The interest rate on a loan against your life insurance policy is crucial because it affects how quickly the loan balance grows over time. Unlike traditional loans, if you do not pay the interest on a life insurance loan, it is added to the loan balance, causing the owed amount to increase each year. This compounding effect can significantly reduce your policy’s cash value and, ultimately, the death benefit.
- Comparison with other loan options: It’s also worth comparing the interest rate on your policy loan with other available loan options. While life insurance loans are generally easier to qualify for, since they require no credit check, the interest rates may be higher than other types of loans, such as personal loans or home equity lines of credit.
Policy lapse risk
- How it happens: If the total loan amount, including accumulated interest, exceeds the policy’s cash value, the policy is at risk of lapsing. This means that your coverage could terminate, leaving you without life insurance protection. A policy lapse not only means losing life insurance coverage but also could have tax implications, especially if your policy has been funded with pre-tax dollars or has accumulated a significant cash value.
- Preventative measures: To prevent your policy from lapsing, it’s important to monitor the loan balance and the cash value of your policy regularly. Some policyholders choose to make at least interest payments to prevent the loan balance from growing too large.
Impact on beneficiaries
- Reduced death benefit: The most direct impact of borrowing from your life insurance policy is on the death benefit. Any outstanding loan balance, including interest, will be deducted from the death benefit that your beneficiaries receive. This could significantly reduce the financial support you intend to leave behind.
- Consider beneficiary needs: Before taking out a loan, consider the needs of your beneficiaries and the purpose of the life insurance policy. If providing for your beneficiaries in the event of your death is a primary concern, it’s essential to weigh the potential reduction in the death benefit against your current financial needs.
Additional charges and fees
- Loan origination fees: Some insurers may charge a fee for initiating a loan against your life insurance policy. This fee, if applicable, would decrease the initial amount you receive.
- Administrative fees: There could also be annual fees associated with maintaining the loan, which could further reduce your policy’s cash value.
- Surrender charges: If you’re considering surrendering your policy to pay off the loan, be mindful of surrender charges. These are fees levied for withdrawing cash value from your policy within a certain period after policy initiation, which can further reduce the amount available to you.
Conclusion
Borrowing against your life insurance policy in India can provide a lifeline during financial tight spots. However, it’s a decision that requires careful consideration of the potential impact on your policy and financial well-being.
Always weigh the immediate financial relief against the long-term implications for your policy’s value and the benefits your beneficiaries will receive. Remember, such a loan should ideally be reserved for genuine emergencies or strategic financial moves, with a clear repayment plan in mind to maintain the integrity and benefits of your life insurance policy.
