What Is a Policy Loan?
A policy loan lets you borrow money against the cash value of a life insurance policy. The loan is secured by the policy's death benefit and cash value, and you repay it with interest.
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Term vs. Whole Life Insurance
Term Life
Term life offers coverage for a set period (10, 20, 30 years). It has no cash value, so you cannot take a loan against it.
Whole Life
Whole life is a permanent policy that builds cash value over time. The cash value grows tax‑deferred and can be borrowed against.
How Policy Loans Work in Whole Life
When you borrow from a whole life policy:
- The loan amount is deducted from the death benefit.
- Interest accrues, usually 4‑8% per annum.
- Repayment is optional; unpaid interest increases the loan balance.
- If the loan exceeds the cash value, the policy may lapse.
Benefits of Borrowing Against Whole Life
1. Tax‑free access to cash, as long as the policy remains in force.
2. Flexibility—use the money for emergencies, education, or business.
3. No credit check or underwriting required.
Risks and Considerations
1. Reduced death benefit if the loan is not repaid.
2. Interest costs can grow quickly, potentially eroding the policy's value.
3. Policy lapse risk if cash value is insufficient.
When to Take a Loan on Whole Life
• Short‑term liquidity needs with no other credit options.
• A strategic investment where the loan rate is lower than potential returns.
• A tax‑efficient way to access funds if you're in a high tax bracket.
Alternatives to Policy Loans
• Traditional bank loans.
• Credit cards (though interest rates are typically higher).
• Reverse mortgages for homeowners.
Key Takeaways
Term life insurance does not allow loans. Whole life policies offer a built‑in loan feature, but borrowing reduces the death benefit and incurs interest. Carefully weigh the benefits against the potential long‑term impact on your policy and estate planning goals.
| Feature | Term Life | Whole Life |
|---|---|---|
| Cash Value | None | Builds over time |
| Loan Availability | No | Yes |
| Interest Rate | N/A | 4‑8% (variable) |
| Impact on Death Benefit | None | Reduced by loan balance |