Should you opt for a loan against a life insurance policy?

At times, one may need to take a loan when a financial emergency comes up. In such a situation a personal loan is one of the quickest options. But is it the best option? Instead of going for an expensive option like a personal loan, there is another option you can consider. This is taking a loan against a life insurance policy.

Rakesh Goyal, Director, Probus Insurance brokers said that there are some benefits of taking a loan against your insurance policy such as lower interest rates and ease of getting loan.

Here are the main advantages and disadvantages of taking a loan against your insurance policy.

A. Advantages of taking a loan against life insurance

1. You get high loan value

The maximum loan you can get against your insurance policy varies from one insurance company to another. Generally, however, policyholders can get loans equal to 80-90 percent of the surrender value of the policy.

Surrender value is the value of the policy that you get when you terminate the insurance plan voluntarily. Goyal said, "If you have an insurance cover of Rs 50 lakh and its surrender value is Rs 20 lakh (at the time of requesting loan), you (policyholder) are likely to get a loan of around Rs 18-19 lakh."

2. You may get a low-interest rate

Interest rates charged by insurance companies on loans taken against their life insurance policies are generally lower than those charged on personal loans. Akshay Vaidya, Head- Term Life Insurance, said that the interest charged on loan taken against a life insurance policy depends upon the premium already paid and the number of times the premium is paid. The more the premium paid and the number of times, the lower will be the interest rate. "Given there is wealth coming from the life insurance policy as collateral, the rate will be lower than an uncollateralized loan," he said.

"Currently, a personal loan will come at an interest rate of 12-15 percent. While in case of loan against life insurance the interest rate charged depends on the insurance company, but it's usually lower than what is charged on personal loans. Going by the past trend, interest rates on loans against insurance policies can be anywhere between 10-12 percent," Goyal said.

3. Quick availability of loan

When it comes to getting quick loans with minimum paperwork, loan against life insurance scores over other types of loan. "Unlike other loans, there is no lengthy and cumbersome application process for the loan against an insurance policy. One can get loans in a matter of days with minimal delays. Typically, policyholders can get loans within 3-5 days of application," Goyal said.

4. Loans are secured and require limited scrutiny

The life insurance policy is pledged as security for repayment of the loan in the event of a default. Hence, you get lower interest rates. Since the loan is secured there is limited scrutiny and the loan can be disbursed quickly. In other cases, lenders usually evaluate your credit scores and charge you interest rates for a loan depending on the score.

B. Disadvantages of taking a loan against an insurance policy

1. You can get a smaller loan amount in the initial policy years

It is widely believed that such a loan can be taken against the sum assured of the policy. However, that's not true, your loan gets sanctioned against the policy's surrender value only. As it may take years for a policyholder to accumulate a significant cash value/surrender value under their life insurance policy, the loan that the policyholder can take against the policy can be limited in the initial years of the policy.

2. Not getting the loan on all type of life insurance

A loan can be taken only against traditional life insurance policies and not against a term plan. Traditional plans include endowment policies, money-back plans, whole life, etc., where there is a guaranteed return.

Goyal said, "Term life insurance policy is not eligible for taking loans. It should be either a traditional plan or an endowment plan. However, several insurance companies give loans against unit- linked insurance plans."

3. There is a waiting period

You won't be eligible for taking a loan against your life insurance plan as soon as you buy it. There is a waiting period of around three years. The lender basically checks whether you have paid the premium, or have defaulted, during the three-year waiting period. Accordingly, the loan is sanctioned basis the surrender value.

4. Default on repayment of a loan

In case of default in repayment of loans or default in payment of future premiums, the insurance policy will lapse. The policyholder needs to pay interest on the loan taken against the policy as well as premiums on the policy. The insurance company also has the right to recover the principal and interest due to the surrender value of the policy.

What policyholders should do

The purpose of buying life insurance is to insure our loved one's financial security in case of one's unfortunate demise. However, in case of any emergency if you want to take a loan against life insurance, then it should be used sparingly only for short-term periods or when the borrower is unable to borrow any other type of loan.

News Source: Economic Times, Url:

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