Is borrowing against your policy a good idea? We explore the viability
We may need a loan at some point in our lives, despite our best planning. A car enthusiast may need a vehicle loan; a loving couple needs a housing loan to get their dream home. Even rich businessmen sometimes borrow money to resolve their liquidity issues.
Whatever your reason may be, it is clear that you want a loan that is available at the right amount and at the decent interest rate. At times, it is quite easy to locate the best type of loan. For example, an interest-free student loan may be the best solution for an aspiring student.
On the other hand, you may have several less-than-favourable options, especially when it comes to personal loans. Your credit rating is at its rock-bottom; the loans available may come at great cost. That is when you may turn to policy loans.
What is a policy loan?
Life insurance comes in two forms – one with savings component and one without. If you have only the latter, this option is not open to you. However, if you happen to be a policyholder of a Whole Life policy or an Endowment plan, the avenue is available for you to make a loan against your policy.
For policies with cash value, the insurance companies are willing to extend a loan to you. The maximum amount that you can obtain is about 80% – 90% of the cash value of your policy.
Why is it a loan when it is your own money?
Technically you are not taking out your money because your policy can only be liquidated upon a claim, surrender or maturity. What is happening here is that the insurance companies are lending you money with your policy as the collateral. That is why they are charging you an interest to take up a loan.
Why you should take up the loan
There are many advantages of borrowing from your insurance policies. For you to consider your options properly, we are listing them down for you to make an informed decision.
Always available for a quickie
You know how the banks and financial companies are always bragging about instant loan approval. A policy loan is one that you require literally no approval. As long as you have sufficient cash value in your policy, the amount is always open for you to obtain a policy loan from. After all, that is one of your privileges when you sign up for your policy.
Due to that, you can always get your money as long as the insurance company is open. Personally, I have seen a policy loan being processed within the day at one of the local insurers. Cash was dispensed at the branch office on the application day itself. Yes, it is that fast.
Reasonable interest rate
What is reasonable is subjective. When pegged against a credit card loan that levies effective interest rates of over 20%, the interest on policy loans is less taxing. We do not have all the figures but from our research, the annual interest rate ranges from 5.75% to 6.75%.
|Insurance Company||Interest Rate|
For those insurance companies which are not listed above, we are unable to locate the rates on their sites. In any case, it is of utmost importance that you ask your insurers about their interest rate because
- We read that an unlisted insurer levies a hefty 8% interest rate
- All the above-listed rates are subject to change.
No repayment necessary
Unlike a personal loan from a financial institution, you do not have to pay back your policy loan.
Yes, you heard us right. Sleep tight at night because no loanshark will come knocking. You will neither be sued in Court or made bankrupt.
Of course there is always a catch and naturally ,it is one of our reasons that you should not borrow from your policy.
Why you should not take up the loan
There are no free lunches in this world so you have to understand there are some downsides to policy loans.
Limited loan quantum
Since the insurance company only allows a certain percentage of the cash value to be taken as policy loan, the obvious disadvantage is that the amount that you can borrow may be meagre, depending on how long you have been servicing the policy.
In fact, you may not be able to obtain any loan if your insurance policy has just commenced not too long ago as it does not have sufficient time to build up any value.
This pales in comparison to other personal loans whereby you may borrow more than your annual income. When you require a large sum of money, this is rather restrictive.
Paying interest on interest
Remember that little fact that you do not have to return the loan? Now here is the kicker.
If you do not repay the loan, interest will accumulate. Soon, you are paying interest on the interest itself on top of the original amount.
“Since no repayment is required, why does it matter?” You asked.
Affects maturity and claim payouts
This is the answer.
When your plan matures or when you are making a claim, the loan impacts the compensation sum that you receive. The insurer deducts the outstanding loan amount from the entitled payout. Therefore the amount that you receive is greatly reduced if you do not repay and allow the interest to build up over time.
If the objective of your plan is to pay for your child’s education or to fund your retirement, this may become a massive problem for you.
A worse scenario is that you are making a claim and the original amount is just enough for you to cope with the injury or illness. Suddenly you are short due to the outstanding loan amount. This is not something you want to happen during an emergency.
Terminates your insurance policy
If you do not maintain your regular premium payment, there is another problem that may go undetected. The remaining cash value that you are unable to borrow from may be diminished to pay for the premium. Over time, your policy may go bust.
The consequence can be dire. By forfeiting your policy at this point, you have to pay a higher premium on the replacement policy as you are now older. Worse, you may not be able to obtain any coverage due to pre-existing conditions.
Taking policy loan may just be your quickest and best option if you are hard pressed for cash. The interest rate may be favourable and you shall not be pressured to repay the sum quickly. At the same time, recognising the long-term consequences is rather important so as to avoid creating a coverage gap that you are not aware of.
The decision ultimately lies with you. When no better choices exist, policy loans may be the life-saver that you need.
www.ClearlySurely.com aims to eradicate the knowledge gap between consumers and Life Insurance. Our Vision is that one day, every Man, Woman, and Child will be properly insured.
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