Borrowing Against Life Insurance? Know Why You Should Avoid It

Life insurance is like a guardian angel, quietly watching over us and ensuring that our loved ones are protected even when we can no longer be there for them. Just as a lighthouse guide ships safely through treacherous waters, life insurance is a shining star of financial security in times of uncertainty. It is a powerful tool that allows you to leave behind a legacy, securing the future of those we hold dear. Life insurance not only provides financial protection to your loved ones in your absence, but some plans also help you save for the future. It can contribute towards long-term goals such as retirement, your child's education, buying property, etc. Some life insurance plans even generate cash value as you pay the premiums, with more value accumulating the longer you've been paying. And did you know that you can borrow money from this accrued cash value under certain plans? Let’s learn more about this feature - in this article.

Borrowing From Your Life Insurance Policy - How Do Life Insurance Loans Work?

As discussed before, certain life insurance plans let you borrow money from the accumulated cash value. However, it's important to understand that borrowing from your life insurance policy can be quite complicated. Here are a few essential things to keep in mind -

• Borrowing Limits
  The insurance company will specify the minimum and maximum borrowing amounts in the policy document.

• Associated Collateral
  When you borrow money from your life insurance policy, it serves as collateral for the borrowed amount. The insurer will automatically have ownership of the policy up to the remaining life insurance policy based on the loan amount.

• Benefit Deductions
  When you or your nominee receive the benefits like the maturity value, death payout, etc., the insurance company will deduct any outstanding loan balance from the entitled amount. This deduction may reduce the financial support that you or your nominee will receive.

• Interest Rates
  The loan interest rate can change at the beginning of each policy year, as set by the insurance company. Aditya Birla Sun Life Insurance calculates its interest rate as the State Bank of India's base rate plus 100 basis points. Currently [as of 1st June 2022], the interest rate is 8.55% per annum. Any changes to the calculation of interest rates for policy loans must be approved by the Insurance Regulatory and Development Authority of India (IRDAI).

Borrowing from your life insurance policy’s cash value may seem like a viable and convenient choice in times of financial need. However, it may not be the best decision.

Why Should I Not Borrow from Life Insurance Policy?

Here are a few reasons why borrowing from your life insurance policy may not be a wise financial choice -

1. Reduction of Death Benefit The primary purpose of investing in life insurance is to create a financial cushion for your loved ones in your absence. And borrowing from your life insurance policy can reduce the amount your nominee will receive if you pass away during the policy period.

When you borrow from your policy, the insurer uses the policy's cash value as collateral. This means that the death benefit of your policy will be reduced by the pending loan amount. As a result, your loved ones may receive less financial support than you had planned to leave behind, which can potentially affect their lifestyle and goals.

2. Interest Rates Despite borrowing against your accrued funds, you are still required to pay interest on the loan. Throughout the duration between taking out the loan and repaying it, the insurance company will charge you interest on the remaining balance.

3. Loss of Your Coverage When you borrow money from your life insurance policy, the interest on the loan accumulates over time as a percentage of the borrowed amount. This means that the total amount you have to repay increases. If you fail to make regular payments and the combined total of the loan interest and unpaid loan amount equals or surpasses the policy's cash value, the policy will lapse. Losing your coverage in this way goes against the very reason for having life insurance in the first place.

Wrapping Up

It is crucial to carefully evaluate the potential consequences before making any decision to borrow from your life insurance policy. Taking a loan can have significant implications on the financial protection you seek to build through life insurance. It is important to fully understand how borrowing may impact your policy's value, premiums, and potential benefits. You can then make an informed decision that aligns with your financial goals and protects the well-being of your loved ones.