When your client wants to borrow from their life insurance

By Lyle Solomon

You may be dealing with clients who are drowning in credit card debt. Many who are in this situation may even want to borrow from life insurance to pay off debt.

Your role as an advisor is crucial in this situation. Your guidance can make a significant difference in your client’s financial future. So, what should be your stance on this matter? Let’s look at the answer.

Can someone borrow from their life insurance policy?

The simple answer is “yes.”

Your clients can borrow from their insurance policies. However, much depends on the type of insurance policy your clients have. If your clients have a universal life or whole life insurance policy and always make payments on time, they must have accrued cash value in the policy.

Your clients can borrow from the cash value in the policy to pay off credit card debt.

For example, your clients have $20,000 in credit card debt, and they are not eligible for a debt settlement program or a debt consolidation loan. However, they have a life insurance policy with a cash value of $30,000. In that case, they can withdraw a certain amount from it and settle credit card debt. They can repay the borrowed amount over time.

If your clients’ financial circumstances don’t improve, they may also avoid repaying the total amount.

Should somebody borrow from their life insurance policy?

Well, this is a tricky question. Borrowing against the cash value of the life insurance policy has a few advantages. The first advantage is that clients only must pay the interest on the loan each year. They don’t have to pay off the principal.

The second advantage is that they don’t have to apply for a loan anywhere else, so they won’t face loan rejections.

What is the process to borrow from a life insurance policy?

The process is simple. All your client needs is an internet connection. The client can call you or the insurance company to find out whether they own a cash value policy.

If the client owns a cash value policy, you or the company can provide the client with the in-force illustration statement, which is proof of owning a cash value policy. This statement includes information such as the overall amount the client can borrow from their insurance policy.

After the client has read the in-force illustration statement, they can request the insurer to email them a policy loan request. In this form, your client (the policyholder) must share their contact details (Social Security number, name, address) and how much money they want to borrow from the policy. Instruct your client to enter the necessary details, sign the form and ask the insurer to send a check to the client’s mailing address within 10 working days.

Inform your client that they don’t need to pay any application fees. There are no application fees, credit checks or multiple questions from a financial institution. No one will ask them how they plan to use the funds.

Can your clients borrow money from all types of life insurance policies?

The simple answer is “no.”

Most people have term life insurance policies, and there is no cash value in those policies. Keep in mind that consumers can take out a loan from cash value life insurance policies only.

Borrowing from life insurance has several benefits as well as drawbacks.

The benefits

1. Clients are borrowing their own money, so they are not answerable to anyone. They are borrowing money from their insurance. They have to pay themselves back eventually.

2. Clients can spend the money as they wish. They can use it to repay creditors, consolidate credit card debt or cover emergency expenses. There is no need to explain to anybody.

3. Repaying the loan is not compulsory. The client must pay annual interest, but there is no compulsion to repay the principal amount. However, there is a catch. If the policyholder fails to pay off the principal, that amount and interest will be removed from the policy’s death benefit.

4. There is no minimum credit score requirement. The insurance company won’t check your client’s credit report. Your clients won’t have to pay application fees or additional expenses.

5. Your client’s credit score won’t be affected in any circumstance. This is irrespective of how many payments your clients eventually make. These payments are not reported to credit bureaus.

6. The interest rates charged on life insurance loans are lower than those of credit cards and debt consolidation loans. Check your client’s life insurance policy. How long have they been paying insurance premiums? Is it more than 10 years? If so, your client could qualify for an interest rate of as low as 4%.

The drawbacks

There are drawbacks to borrowing from life insurance policies. Here are a few of them.

• Only policyholders can borrow from life insurance policies.

• Your clients may lose some death benefits if the loan is not repaid.

• This feature is not available on term life insurance policies, which most people buy.

• Policyholders must pay premiums for a prolonged period. This may extend for 15-20 years.

Are there any tax liabilities?

Although there are no tax liabilities for borrowing against a life insurance policy, there are a few things people should be aware of.

If there isn’t enough cash value or the insurance policy has lapsed, the client may have to pay a tax. Although this is less likely to happen, speaking to a financial advisor before borrowing any money is better.

How much can someone possibly borrow?

Policyholders can borrow a large fraction of the cash value of the life insurance policy. The annual statement gives policyholders an idea of the total cash value. If policyholders are unsure of the correct amount, they can speak directly to the customer service representative or the insurance agent. They can give the insurance policy number to get the right details.

What to do after taking out a life insurance loan

Borrowing from a life insurance policy can be a good way to get out of high-interest credit card debt. But there are a few things policyholders must do after borrowing money.

• Calculate the compounding interest rate on the loan.

• Set up a loan repayment schedule.

• Stick to the repayment schedule and make payments accordingly.

Ask your clients to read the terms and conditions of the life insurance policy. It is important to remember that not all policies are the same. Clients must abide by all the terms to implement this form of debt consolidation. But the good part is that policyholders can pay off any kind of debt with a life insurance policy loan. From student loans to credit card debt, nothing is exempt. Life insurers offer borrowers great flexibility.