Loan Against an Insurance Policy: Is It a Good Idea?

Posted in Lending Articles By Chanel Rick - Sep 22,2022
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In the face of fiscal adversities, every decision steers you closer to financial freedom or debt. The intensity of such situations might trigger natural responses like fight or flight. Or, the third, lesser-known instinct, freeze. Giving into flight instinct may lead to ill-informed moves like absconding, but being a fugitive is not the way to deal with such a problem. Aside from the legal implications, it will make returning to a life of normalcy difficult.

So, what about fighting your way out? Start by assessing your current finances. There must be something in your arsenal of assets and acquisitions that could be handy. Perhaps, something in that investment portfolio? But, the market has been performing poorly of late, and panic-stricken sell-offs would only multiply your losses.

Maybe you could sell hand-me-down gold ornaments? But, these expenses are temporary, and the sale of assets could deal more damage than good. With limited options, you might have to get more creative. Here’s an out-of-the-box idea. How about taking a loan against your life insurance?

Don’t look so surprised! 

In the United States, citizens opt for loans against their life insurance policies to avail of funds. While it’s an option available in India as well, very few people are aware of it. Since these policies offer a sizeable sum insured to the surviving dependants, it could surely benefit the policyholder before their demise. And they do!  

Loan Against Insurance Policy: What Does it Entail?  

While fulfilling the basics of personal finance, purchasing life and health insurance are some checkboxes. The former ensures that your family isn’t left financially vulnerable in case of your untimely death. Life insurance provides the surviving dependants with a sum insured, which the policyholder must pay a premium for.

When a short-term financial emergency arises, you can avail a loan against your life insurance policy. However, there are certain conditions to avail such loans. And these loans are only recommended to mitigate temporary financial constraints. Every insurance provider and bank has a policy for loans against life insurance. Generally, these loans are sanctioned against unit-linked insurance plans (ULIP) and endowment plans.

Applying for a loan against life insurance policies is a great alternative to personal loans. These loans don’t secure any collateral by way of assets and are secured loans since they are tied to an active policy. The cash value of the policy acts as collateral in such cases.

But, like most things, there is no clear-cut way of opting for loans against insurance policies. Certain factors impede the benefits of such facilities.

Factors to Consider: The Pros & Cons  

Before rushing to call your insurance provider, evaluate the advantages and disadvantages of taking out such a loan. There’s a possibility that a rash decision might further complicate your financial condition. Weigh the following pros and cons to understand whether the benefits of these loans outweigh the consequence and risks involved.

The Pros

1. High Loan Value

The maximum amount borrowers can request through the loan varies among insurance companies. They usually sanction up to 80% to 90% of the surrender value. A surrender value is calculated against the total value of the policy during its termination. If the life insurance has been active for a major portion of the tenure, borrowers could receive a considerable loan amount sanctioned.

2. Lower Interest Rate  

Unlike personal loans that usually charge a hefty interest, a loan against life insurance is comparatively lower. The interest levied on such loans depends on the premiums the policyholder has already paid in the tenure. If several timely premiums have been paid, there’s a strong possibility that a low interest is applicable.

3. Quick Access to Funds

Since policyholders already have an existing relationship with the insurance provider, it’s easier to avail a loan with minimal documentation. With fewer documents requested, the process can be expedited and completed within a day. 

4. Secured with Limited Scrutiny

By availing a loan against life insurance, borrowers are pledging the policy as security for repayment of the loan. In the event of a default, the life insurance will be used as collateral. Due to the nature of the loan, borrowers can receive the amount for lesser interest. Since it’s a secured loan, it can be disbursed much sooner. 

The Cons

1. Smaller Loan Amount

Unless borrowers wait a few years after purchasing life insurance, they’re unlikely to receive a substantial loan. Contrary to some beliefs, the loan is only sanctioned against the policy’s surrender value, not the sum assured. Policyholders must wait a significant period to accumulate a sizeable surrender value. Hence, a loan against the insurance early in the tenure will not fetch substantial amount.  

2. Policy Eligibility Concerns 

These loans apply only to certain types of life insurance policies. Borrowers can only opt for loans against traditional life insurance policies, not a term plan. These traditional policies include endowment policies, money-back plans, whole life, etc. Essentially, it’s available only on guaranteed return policies.  

3. Waiting Period 

Before applying for a loan against life insurance, borrowers must verify the waiting period for such loans. While the waiting period differs between insurers, it’s typically around three years. Within that period, the lenders scrutinise the borrowers’ premium payment history to check for any defaults. Based on this data, the lenders sanction the loan as per the surrender value estimated.  

4. Defaults on Repayment

Without adequate financial planning, borrowers might fall deeper into debt while repaying the loan and managing premium payments. In case they default on a premium, the insurance policy will lapse. Moreover, a default in loan repayment would cause the borrowers to forfeit the rest of their pledged policy’s surrender value.

What’s the final verdict?

Wisely use the option of loans against life insurance policies as a last resort to fulfil short-term, urgent financial obligations. It’s a quicker means of accessing funds at a lower interest, but it comes with some risks caused by defaults and poor money management.  

Avoid letting those financial constraints push you into a corner – apply for an effortless and quick loan on Bajaj Markets today!  

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