Loan Against Life Insurance Policy - 6 Factors You Should Know

 There are a variety of loans available in Indian markets - property loans, gold loans, loans against fixed deposits, loans against mutual funds, etc. Did you know that you can also avail a loan against your insurance policy?

Well yes, you can. If you own a traditional life insurance policy, i.e, a policy that includes a savings component, for instance, Endowment Plans or Money-Back Plans, you can avail of a loan against it for any financial goals (buying a house, funding your child’s higher education, home improvement, etc.) or emergencies (hospitalisation costs, etc.). 

These loans are provided to you by the insurance company, NBFC, or bank. However, it is important to note that loans aren’t available for all types of insurance policies. For instance, Term Insurance Plans since they only give you a death benefit and have no cash value. ULIPs may also not be eligible since their returns are linked to the stock market and hence, aren’t fixed.

• 1. You don’t need any additional collateral to secure the loan.
• 2. The interest rates are lower as compared to other loan avenues
• 3. The loan amount is non-taxable. 

What essentially happens is that your policy is pledged in exchange for the loan. The value of the policy is the collateral for the loan. This can happen only after your policy acquires a Surrender Value, i.e. when you’ve paid the premiums regularly for the first 2-3 years. 

There are a few things you should keep in mind before availing of a loan against your insurance policy. Let’s have a look!

1. Eligibility - There are two types of eligibilities when it comes to loans against your insurance policy -  

• a. Policy Eligibility -
  The very first thing you need to check is whether your policy is eligible to serve as collateral for the loan you’re intending to take. As discussed before, policies with a savings component (Endowment Plans, Money-Back Plans, Whole Life Plans, etc.) are eligible for the same. On the other hand, policies like Term Plans do not qualify for loans. Secondly, you can only avail of the loan if your policy has acquired a surrender value, i.e., if you have paid the premiums for 2-3 years regularly.
• b. Policyholder Eligibility -
  A loan against an insurance policy basically means a loan from yourself. So, you may not have to undergo any strict approval process and your income isn’t a deciding factor for approval of the loan. However, your general creditworthiness might be considered. Please go through all the T&Cs of your insurance policy carefully to know about the same.

2. Loan Amount

The insurance company will define the minimum and maximum limits of the loan. It is a percentage of the Surrender Value and can go up to 85-90% for plans with guaranteed returns.    
 
Please Note: If your ULIP does offer you a loan facility, the loan amount depends on the current fund value and type of fund.   
 
Once the loan amount is decided, the insurance policy is pledged and all rights are transferred to the lender. The loan amount is given to the policyholder.

3. Interest Rate

The rate of interest depends on the number of premiums and the premium amount already paid. The higher the number and amount, the lower the interest rate.  Also, the interest rates may change from year to year. It is wise to keep a track of relevant changes to know the interest rate for the year you’re taking a loan. 

4. Documentation - There are three main documentation steps – 

• Filling out the pre-prescribed application form.
• a. Filling out the pre-prescribed application form.
• b. Submitting the original policy document to the insurance company or lending entity which you are taking the loan from.
• c. Signing a deed of assignment by which your rights are assigned to the lender.

Please note that there may be different documentation processes for different insurance companies. Check with your insurance company to know more.

5. Premiums
 You will need to continue paying the policy premiums even when the loan is active. Some insurance companies may terminate your policy if you don’t.

6. Repayment Of The Loan
You are required to pay the loan back to the entity during the policy term and can pay either

• a. Principal Amount (initial loan amount taken by you) + Interest
  Here, the entire amount is paid during the policy term.
• b. Only Interest -
  b. If you pay only the interest, the principal is deducted from the claim amount. The remainder is paid as the maturity/death benefit. A point of concern here is that if your nominee is dependent on the claim amount in your absence, this deduction will severely affect their financial security. You should, therefore, exercise caution where repayment is concerned. 

Please note: If the due interest exceeds your policy’s Surrender Value, you may risk losing the insurance cover.

 This brings us to the end of this article. We hope you’ve now understood the various facets of availing of a loan against your insurance policy. Ensure that you go through all the T&Cs of the loan facility to avoid any surprises later.