Generally, a life insurance policy serves to provide risk cover and depending on the policy, it can also offer savings. But, if you’re looking for some immediate injection of cash, you can also take out a loan on life insurance policy. This has a few benefits, especially if you have a low credit score and want to bypass personal loan or secured loan interest rates, considering your monthly income.
But how does a loan on life insurance policy work? Does it work with popular life insurance plans? And who provides these loans?
We will take a look at these questions and more in the segment below.
About loan against Life insurance
The loan is provided by using the policy as a security. It is usually provided by insurance companies (sometimes the same insurance company which holds your policy will offer you the loan), banks and other NBFC who generally offer loans against security.
Types of plans eligible for loan
However, there are only certain types of life insurance plans which are considered by banks and insurance companies when it comes to taking out a loan. Endowment plans and money-back plans have more acceptability in such cases, while term insurance plans and ULIP (unit-linked insurance plans) are overlooked.
The reason for such selection is that loans are only offered against policies which hold surrender values. Term insurance plans are only payable on the death of the insured during the tenure of the plan, which in most cases is 20-30 years. Since a loan typically lasts 10-15 years at the most, the loan provider will not be able to use the policy to recoup their loan amount. Similarly, a ULIP is linked with the equity market and regulations restrict companies to offer loans based on ULIPs since the value of the policy is not fixed and changes with the market scenario.
As a result, popular insurance plans which are either endowment based plans or money-back plans are more acceptable as a security since they have a minimum surrender value. However, the surrender value does not generate before 2-3 years of annual premium payment. In other words, your policy only has value if you’ve taken on a life insurance policy in 2018 and continue to pay your premium timely till 2020 (including 2020’s premium). Even at that point, the surrender value is only 30% of the total possible value (assuming your policy tenure is 10 years).
Calculation of loan value
The bank or insurance company that is granting you the loan will use this surrender value as security for extending you the loan. The loan amount generally varies between 70-90% of the surrender value based on the type of loan and other factors. The interest rates on these kinds of loans vary around 10%, which is considerably cheaper than other forms of secured loans and especially cheaper than personal loans, which have interest rates as high as 18%.
Documentation for a loan on life insurance
But before the loan can be disbursed, the loan providing organisation will require you to assign them as the beneficiary to the policy, so that they can use the surrender value, in case the loan goes unpaid. There is a particular format for this communication and usually varies from company to company. In addition to assigning the policy, you would also need to submit the original copy of the policy with a loan application.
Repayment of loan
Once the loan is disbursed, you have the option to repay principal + interest on an annual basis (or whatever payment schedule mutually agreeable to you and loan provider). Alternatively, you can also opt to pay for the interest only and have the premium deducted from your surrender value, which will be cashed in by the loan provider once the policy matures.
The Bottom Line
In conclusion, loan on life insurance policy offers a unique way to get some extra cash when you’re facing a cash crunch, but without having to pay over-your-head interests. Alternatively, since the surrender value only reaches 100% upon payment of full term, it restricts the amount of loan that can be taken. Additionally, if the interest due on loan exceeds the surrender value, you run the risk of losing your life cover.