Think Before You Borrow: The Hidden Risks Of Loans Against Life Insurance

A loan against insurance is a secured loan that you can borrow against an insurance policy on which you have been paying premiums regularly.  Banks and insurance companies allow loans against most types of insurance, though not against term insurance policies. The loan amount is in the range of 60 per cent to 90 per cent of the surrender value of the insurance policy.

“You can apply for a loan against an insurance policy only if you purchased your policy at least three years prior to the loan application, and if the insurance is no longer in the lock-in period. Besides, the loan processing cost, interest rates on loan, and documentation for loan against life insurance are quite less and hassle-free compared to taking a personal loan, as it is a secured loan,” says Adhil Shetty, CEO, BankBazaar.com.

Loan Against Insurance: The Benefits 

A major benefit is that it is quick and easy to access funds without completing lengthy forms or undergoing credit checks. It is reasonable if you are going to lose some cash quickly and you do not want to destroy long-term assets. 

“The unfortunate downside is it erodes your policy benefits. Badly used, it could lessen what your loved ones receive at a later stage. It is reasonable if you are confident, you can repay it and mess up longer-term financial plans. But if you don't know how you'll repay it or if it is your only life cover, maybe do not take it,” says Kunal Varma, Founder and CEO, Freo.

Be Extra Careful 

Hence, although you can get a loan against your insurance policy easily, you need to be extra careful not to default on premium payments to keep the policy active. In such a situation, your policy will lapse, and the insurer has the right to recover the dues from the surrender value of the policy. “If such a thing happens, the very purpose of taking a life insurance policy to secure yourself and your family falls flat, although you may achieve your short-term financial requirement. Hence, it is important to weigh your options before you opt for a loan against life insurance policy,” says Shetty.

Your policy continues to earn returns and bonuses (if applicable) normally if you repay the loan and interest on time, and the impact is minimal to none. However, any default may have a significant impact on your final payout. “If you fail to repay, the insurer can use the policy’s surrender value to recover the dues. Your nominee may also receive reduced death or maturity benefits for your nominee if the loan isn’t fully repaid. Also note that the loan eligibility is based on the surrender value and not the maturity value of the policy,” says Shetty. 

So, be clear about the amount of the policy's value you can borrow, the interest you'll pay, and the repayment method.  Determine how the loan will affect any potential returns or bonuses.  “The most important thing, though, is not to forget it is a loan, not free money.  If you don't pay the loan back, your ultimate insurance payout could be jeopardized,” says Varma.