Life insurance is primarily designed to provide financial security for your loved ones in the event of your death. However, certain life insurance policies in Canada also offer the option to borrow against the cash value component. This feature can provide policyholders with access to funds when they need it most, but it’s crucial to understand the ins and outs before making a decision. In this guide, we’ll dive deep into the concept of borrowing against life insurance in Canada, exploring eligibility, processes, benefits, and potential risks.
What is Borrowing Against Life Insurance?
Borrowing against life insurance, also known as taking out a policy loan, involves leveraging the cash value of a permanent life insurance policy as collateral for a loan. This option is available for policies such as whole life insurance, universal life insurance, and variable life insurance, which accumulate a cash value over time. It’s important to note that term life insurance policies do not have a cash value component and, therefore, do not support borrowing.
How does borrowing against your life insurance policy work?
Assuming you have a life insurance policy with cash value, you can borrow against your life insurance policy at any time and for any reason. A life insurance policy loan is different from a bank or credit card loan in certain aspects, such as:
- It does not affect your credit score
- There is no credit check or approval process because you are essentially borrowing from yourself
- You do not need to explain why you are borrowing or how you plan to spend the money
- The loan is not subject to tax, provided it does not exceed the amount paid in premiums and your life insurance policy is in force
To take out a life insurance policy loan, you need to contact your insurer. You can expect speedy approval if your life insurance policy has accumulated enough cash value.
How much Can you Borrow from your Life Insurance Policy?
How much money you can borrow against your cash value varies from one insurer to the next. All the same, most insurers let you borrow amounts as high as 90-95% of the life insurance cash value.
Since the insurer uses the cash value as collateral, the loan is approved quickly, without any credit check or lengthy procedures. The insurer will not ask you to pay it back within a set period. However, keep in mind that interest will be added to your loan amount. So, the longer you defer repaying, the greater the outstanding loan amount will be.
Types of Life Insurance Policies That Allow Borrowing Against Life Insurance
Some life insurance policies, like whole life, universal life, and variable life, let you borrow against their cash value. Here’s a quick look at how they work.
Whole Life Insurance
This type of policy provides lifelong coverage and includes a guaranteed cash value component that grows at a fixed rate determined by the insurer.
Universal Life Insurance
Universal life policies offer more flexibility than whole life insurance, allowing policyholders to adjust premiums and death benefits within certain limits. The cash value growth is based on current interest rates.
Variable Life Insurance
With variable life insurance, the cash value is invested in sub-accounts similar to mutual funds. The growth of the cash value depends on the performance of these underlying investments.
Eligibility Requirements for Borrowing Against Life Insurance
To be eligible to take out a loan against your life insurance policy, there are several requirements that typically must be met:
Having a Permanent Life Insurance Policy
As mentioned, only permanent life insurance policies with cash value allow for policy loans. Term life insurance does not make you eligible. Examples of eligible permanent life policies are whole life, universal life, variable life, etc.
Accumulated Cash Value
Your policy must have accrued a sufficient cash value amount to borrow against. Most insurers require a minimum of $2,000-$5,000. Newer policies without much cash value yet will not be eligible for a sizeable loan. The more cash value you have accrued, the more you can potentially borrow.
Paying Annual Premiums
You must be up-to-date on paying your annual or monthly premiums in order to qualify for a policy loan. If you have missed premium payments, you may be ineligible until you clear any outstanding premiums owed.
Meeting Age/Duration Requirements
Some insurers may require your permanent life insurance policy to have been active for a minimum duration before allowing borrowing. This is often 5-10 years. There may also be minimum age requirements, such as being at least 18 years old or at most 70-80 years old.
Maintaining a Good Standing Status
If your policy is under review, dispute, or considered high risk, you may not be permitted to take out a loan until issues are resolved. Make sure your account and payments are in good standing first.
Limitations on Loan Frequency
Insurers often limit policy owners to one or two outstanding loans at a time. New borrowing may be restricted until existing loans are paid down.
How to Borrow Against Life Insurance?
Borrowing against your life insurance can be straightforward if you follow the right steps. Here’s a simple, five-step guide to help you access the cash value of your policy.
Step 1: Contact your life insurance company
To begin, make sure that your current life insurance policy is eligible to serve as collateral for a loan from your provider. The best way to do this is to contact your life insurance company directly. Speak with a representative to learn whether your policy qualifies for loans or if there are cash value or policy timeline milestones you still need to meet before becoming eligible.
Step 2: Determine how much you can borrow
Most leading insurers in Canada allow you to borrow up to 90% of the cash value of your life insurance policy. With such a policy, if you have $10,000 in cash value, you would be able to borrow up to $9,000 as a loan.
Step 3: Evaluate interest rates and loan terms
Before you proceed with a life insurance loan, make sure the loan interest rate and terms set by your provider work for you. Review the terms of the agreement and make sure you read the fine print for the loan’s terms and obligations. If you don’t understand some of the loan language or are still struggling to make a decision, ask a financial advisor for help.
Step 4: Complete a policy loan application
Next up is to complete a policy loan application. This may be as simple as telling your provider which life insurance policy you want to use as collateral for the loan and providing some information about where you would like the funds to be deposited.
Step 5: Wait for approval and receive funding
At this point, you must wait for the approval process to conclude and for the funds to be deposited into your account. The timeline for this can vary by provider but be prepared for a wait of up to a month for the approval to be made and the cash payout to be completed.
6 Advantages of Borrowing Against Life Insurance Policy
Let’s explore the key advantages of this financial option.
Easy Access
With a poor credit score, getting a personal loan is anything but easy. That is not the case, however, with a life insurance loan. Because the insurer uses the life insurance policy’s cash value as collateral, it does not run a credit check.
Does not hurt your credit score
A life insurance policy loan does not require a credit check. So, it does not hurt your credit score. Nor does it show up on your credit report, which can be especially helpful if you are looking for additional funding.
Low Adjusted Interest Rate
Borrowing from life insurance is essentially a loan, so there will be interest on the loaned amount. But since your remaining cash value continues to earn gains, the adjusted rate is much lower than you would pay on a comparable credit card or bank loan.
Flexible Terms and Loan Amount
When you take a life insurance policy loan, you can pick a payment schedule that best suits you. If needed, you can even modify it later. And if you find you cannot repay the loan, you do not have to. However, you may face tax consequences if your life insurance policy lapses.
Tax-free Loans
Insurance loans are tax-free, as long as your life insurance policy is in force and the amount you borrow does not exceed the amount you contributed.
No Origination Fees
Typically, you do not have to pay an origination fee when you borrow against cash value. Consumer loans, however, usually charge this fee.
4 Disadvantages of Borrowing Against Life Insurance Policy
Borrowing from your life insurance has downsides, like lower death benefits and added interest. Here’s what you need to know.
You can lose coverage if you cannot repay
If you do not repay the loan, the insurance carrier will take the money from your life insurance policy’s cash value. And when the cash value depletes, your coverage will lapse. If you pass away before paying the loan, the life insurance company will deduct the outstanding balance from the death benefit.
The amount available to borrow is negligible during the initial years
Permanent life insurance policies accumulate cash value slowly, picking up the pace. The amount available to borrow for the first 5 to 8 policy years is likely to be small. Generally, it takes about 10 years or so for a life insurance policy to build sufficient funds to make borrowing worthwhile.
Possible tax consequences
While life insurance policy loans are typically tax-free, they can be subject to tax in certain situations. For instance, if you borrowed more money than you paid in premiums and the policy terminates, you will get a tax bill. You will not have to pay tax on the entire loan amount, though. Instead, only that portion of the loan that exceeds the total amount you contributed to the policy will be taxable.
Depletion of an emergency fund
Your policy’s cash value can help keep the life insurance policy active if you cannot pay premiums. However, if you borrow a sizable portion of the cash value, there might not be enough reserves to provide this cushion. Your life insurance policy may lapse after the first or second unpaid premium.
Repaying the loan borrowed against the insurance policy
Paying back the loan against your life insurance policy’s cash value is optional. However, if you do not repay, either of these scenarios may play out:
- If you do not repay the loan, you risk losing coverage if you stop paying premiums.
- If you never repay the loan during your lifetime, your beneficiaries will. The insurance carrier will reduce the death benefit by the amount you borrowed, which means your loved ones will receive less money than you intended.
If you decide to repay, you can construct a repayment schedule that works best for you. Also, you can make periodic payments with annual interest or pay only the annual interest.
Comparing Borrowing Against Life Insurance to Other Loans
Borrowing against a life insurance policy’s cash value can provide faster access to funds compared to traditional loans, with typically lower rates and fewer application hurdles. It is unsecured like a personal loan, meaning you don’t use an asset like your home for collateral. But an unpaid policy loan could lapse your coverage, whereas the main risk with secured loans like mortgages is repossession of the collateral. Consider which option best aligns with your financial situation.
| Loan Type | Interest Rates | Application Process | Risk if Unpaid | Collateral |
| Life Insurance Loan | Typically lower | Faster approval | Could lapse policy | Cash value |
| Personal Loan | Higher rates | Lengthy credit checks | Damages credit | None |
| Mortgage | Relatively lower | Moderate timeline | Home repossession | Your home |
Should you borrow against your life insurance policy?
There is no one-size-fits-all answer. It all depends on your situation. Some of the things to consider are:
- Check how the life insurance policy loan and interest will impact the life insurance policy. Make sure your death benefit will not be eroded, especially if you have people who financially depend on you.
- Ensure you can afford the loan and interest. While repaying the loan is not compulsory, not paying it will have consequences. Make sure you are okay with them if you plan not to repay or to repay only a part of it.
- The insurer will charge a compound interest rate. If you do not pay off the interest debited, you will be paying interest on interest.
Generally speaking, taking a life insurance policy loan can make sense if:
- You do not have any better option available for raising cash.
- Your family no longer needs the death benefit.
- You plan to borrow only a small portion of your cash value.
- You plan to repay the loan soon.
The Bottom Line
Borrowing against life insurance can give you access to quick cash, no questions asked. However, a life insurance policy loan can impact your life insurance policy in many ways. So, weigh the pros and cons carefully before making a decision.
If you are considering borrowing against your life insurance policy, take the time to review your policy details, assess your financial situation, and compare alternative borrowing options. Consult with your insurance provider, financial advisor, or tax professional to ensure you have a clear understanding of the implications and to determine if a policy loan is the right choice for your unique circumstances.
FAQs About Borrowing Against Life Insurance in Canada
Can you borrow from your life insurance?
Your ability to borrow against the value of your life insurance policy will depend on your policy type and your provider's rules for life insurance loans.
What type of life insurance can you borrow from?
Life insurance you can borrow from must be of a type known as permanent. Unlike term life insurance, permanent policies have a cash value against which you can borrow.
What happens if you don't pay back a life insurance loan?
If you don't make any payments toward your outstanding loan balance, the insurance company will eventually start tapping some of the cash value of your account to cover interest costs. This can lead to a situation where you owe more than you have borrowed. If and when that happens, your provider could void your policy.
Does borrowing against my life insurance policy impact my policy value?
Generally speaking, borrowing against your life insurance policy won't impact your policy value. However, this only counts when you fully repay the loan before you pass away. If you pass away before the loan is repaid, part of your policy's death benefit will be used to repay the loan, meaning your beneficiaries will receive a smaller death benefit.
How soon can you borrow against a life insurance policy?
If you can borrow against your life insurance, that option typically kicks in as soon as you accumulate enough cash value in the policy to serve as collateral for a loan. That accrual does not begin immediately, however. Permanent life insurance policies generally begin accruing cash value a year or more after they are activated.
