Borrowing against life insurance can work if you need cash and have a permanent policy, but the loan reduces your death benefit and costs money in interest — it is not free access to your own money.
A policy loan lets you borrow against the cash value of a permanent life insurance policy (whole life, universal life, or variable universal life). The insurance company lends you money using your policy's cash value as collateral. You pay interest on the loan, and if you die before repaying it, the insurance company deducts what you owe from the death benefit your beneficiaries receive.
Whether this is a good move depends on what you need the money for, what interest rate you will pay, and whether you can afford to repay it. It is not an emergency fund — it takes time to process, and the costs can add up fast if you carry the loan for years.
Key Takeaways
- A policy loan uses your cash value as collateral and does not require a credit check or approval process like a bank loan does.
- Interest rates on policy loans typically range from 5% to 8% depending on your policy and insurer, and unpaid interest compounds over time.
- Any loan balance you do not repay reduces the death benefit your beneficiaries receive dollar-for-dollar.
- If you stop paying premiums while carrying a policy loan, the loan balance can consume your cash value and cause the policy to lapse.
- Policy loans work best for short-term needs where you have a realistic plan to repay within a few years.
How a policy loan actually works
When you take out a policy loan, the insurance company does not withdraw money from your cash value — it lends you money and holds your cash value as security. Your policy stays in force, and you keep earning whatever growth or dividends your policy type provides. You do not lose ownership of the cash value; it simply cannot be withdrawn or borrowed against again until you repay the loan.
The loan process is faster than a bank loan. You call your insurance company, request the loan amount, and the money typically arrives within days. There is no credit check, no income verification, and no application fee. The insurer already knows your health status and policy details.
You are responsible for paying interest on the loan. The rate is set in your policy contract and does not change — it might be fixed at 6%, for example, or it might be tied to a benchmark rate like the prime rate plus 1%. Interest accrues whether you pay it or not. If you do not make payments, unpaid interest is added to the loan balance, and you start paying interest on the interest.
What it costs and what happens if you do not repay
The real cost of a policy loan is the interest you pay plus the opportunity cost of not having that cash value grow. If your policy would have earned 4% annually and you borrow at 6%, you are losing 10% in relative value each year — the 4% you are not earning plus the 6% you are paying.
If you die before repaying the loan, your beneficiaries do not get the full death benefit. The insurance company deducts the outstanding loan balance (principal plus unpaid interest) from the payout. If you borrowed $50,000 and still owe $45,000 when you die, your beneficiaries receive $45,000 less than the policy promised.
If you stop paying premiums on the policy while carrying a loan, the situation deteriorates quickly. The insurance company will use your cash value to cover the premiums. The loan balance stays the same, but your cash value shrinks. Eventually, the cash value runs out, the policy lapses, and you lose all coverage. At that point, you still owe the loan balance to the insurance company.
When a policy loan makes sense
A policy loan is reasonable if you need money for a specific, time-limited purpose and you have a realistic plan to repay it. Examples include covering a medical deductible, making a down payment on a car, or bridging a gap during a job transition — situations where you know the money is temporary and you expect your cash flow to improve.
It also makes sense if you have exhausted other options. If you cannot get a bank loan because of credit issues, and you have a permanent life insurance policy with substantial cash value, a policy loan is available to you when nothing else is. The trade-off is that you are reducing your death benefit and paying interest, but at least you have access to the money.
A policy loan is less attractive for ongoing expenses or indefinite needs. If you are borrowing to cover regular bills because your income is not enough, a policy loan is a temporary patch, not a solution. You will eventually run out of cash value or find yourself unable to repay, and your coverage will collapse.
Policy loans versus surrendering the policy
If you need cash, you have two main options: borrow against the policy or surrender it and take the cash value. A policy loan keeps your death benefit in place (though reduced by the loan balance). Surrendering the policy gives you the full cash value but ends your coverage permanently.
Surrendering also has tax consequences. If your cash value exceeds what you paid into the policy in premiums, the excess is taxable income in the year you surrender. A policy loan does not trigger a tax bill unless the loan balance exceeds your total premiums paid, which is rare.
If you think you might need the life insurance in the future — even if you do not need it right now — a policy loan preserves that option. Surrendering closes the door. Once the policy is gone, you cannot get it back, and if your health has changed, you may not be able to buy new coverage at an affordable rate.
Comparing policy loans to other borrowing options
A policy loan is not always the cheapest way to borrow. A personal loan from a bank or credit union might have a lower interest rate if your credit is good. A home equity line of credit (HELOC) or home equity loan is often cheaper if you own a home. A credit card cash advance is more expensive but faster.
The advantage of a policy loan is that it requires no credit check and no income verification. If you have poor credit or unstable income, a policy loan may be your only option. It is also private — the loan does not show up on your credit report, so it does not affect your credit score or your ability to borrow elsewhere.
The disadvantage is that you are betting against your own death benefit. If you die while carrying the loan, your family gets less money. That is a real risk if you took out the policy specifically to protect them.
Steps to take before borrowing against your policy
Call your insurance company and ask for a current policy statement showing your cash value, the loan interest rate in your contract, and any outstanding loans or policy loans already in place. Do not assume you know the rate — it varies by policy and company.
Calculate what the loan will cost you. If you borrow $30,000 at 6% interest and plan to repay it over five years, use an online loan calculator to see the total interest paid. Many people are surprised by how much interest accumulates.
Make sure you have a realistic repayment plan. Do not borrow assuming you will "figure it out later." Know how much you can pay each month and how long it will take to clear the balance. If you cannot commit to a timeline, do not take the loan.
Consider whether you should explore other borrowing options first. Call a bank or credit union and ask what rate you would may have access to for. It takes five minutes and does not hurt your credit. If you can borrow cheaper elsewhere, do that instead.
Frequently Asked Questions
Can I borrow against a term life insurance policy?
No. Term life insurance has no cash value, so there is nothing to borrow against. Only permanent policies — whole life, universal life, and variable universal life — build cash value. If you have term insurance and need cash, you would have to surrender the policy and lose your coverage.
What happens if I die with an unpaid policy loan?
The insurance company deducts the outstanding loan balance (principal plus any unpaid interest) from the death benefit before paying your beneficiaries. If you borrowed $40,000 and still owe $38,000 when you die, your beneficiaries receive $38,000 less than the policy face amount.
Do I have to pay taxes on a policy loan?
Generally, no. A policy loan is not taxable income because it is a loan, not a withdrawal. However, if the total amount you borrow exceeds your total premiums paid into the policy, the excess is taxable. This is rare but possible with older policies or policies that have earned substantial dividends.
Can I borrow more than my cash value?
No. The insurance company will only lend up to your current cash value, minus any existing loan balance. If your cash value is $50,000 and you already have a $10,000 loan outstanding, you can borrow up to $40,000 more.
What if I cannot repay the loan?
If you stop making payments, unpaid interest compounds and the loan balance grows. The insurance company will eventually use your cash value to cover your premiums and the loan interest. When the cash value runs out, your policy lapses and you lose coverage. You still owe the loan balance to the insurance company.