Quick answer: A policy loan is a loan from your life insurance company that uses the cash value in your permanent life insurance policy, like whole life, as collateral. You are not taking money out of the policy. The company lends you its money, and your cash value backs the loan. You pay interest, and you choose when to pay it back. If a loan is not repaid, the balance plus interest is taken out of the death benefit. If the loan grows too large, the policy can lapse.
We talk about policy loans a lot because they are a key part of the infinite banking idea, also called being your own banker. Here is how they work in plain English. This is education only, not financial, tax, or legal advice.
Step 1: You Build Cash Value
A whole life policy has a death benefit and a cash value. As you pay premiums, part of the money builds cash value inside the policy over time. It often grows slowly in the early years.
Step 2: You Ask for a Loan
When you have cash value, you can usually ask the insurance company for a loan. There is usually no credit check, because the cash value secures the loan. You can often borrow up to a percent of your cash value, set by the company.
Step 3: Your Cash Value Stays in the Policy
This is the part that surprises people. With a policy loan, your cash value is not withdrawn. It stays in the policy. Depending on the policy and the company, it may keep earning, though some companies treat borrowed cash value differently. Ask how your company handles it.
Step 4: Interest Is Charged
The company charges interest on the loan. The rate and whether it is fixed or variable depend on your policy. Unpaid interest is usually added to the loan balance.
Step 5: You Choose How to Repay
Policy loans usually have flexible repayment. You can pay on a schedule, pay when you can, or not pay at all. Many people who use the infinite banking idea choose to repay on a set schedule, like they would a bank, to rebuild their cash value.
The Risks to Know
- Lower death benefit. Any unpaid loan and interest is subtracted when the policy pays out.
- Lapse risk. If the loan plus interest grows bigger than the cash value, the policy can lapse.
- Taxes. If a policy with a loan lapses, there may be tax consequences. Talk to a tax professional.
- Design matters. How the policy is set up affects how much cash value is available and when.
Policy Loan vs Withdrawal
A withdrawal takes money out of the cash value and can lower the death benefit for good. A loan borrows against the cash value. They are not the same, so ask which one you are doing.
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Frequently Asked Questions
Is a policy loan the same as a withdrawal?
No. A loan borrows from the insurance company using your cash value as collateral. A withdrawal takes money out of the cash value.
Do I have to pay back a policy loan?
Repayment is usually flexible, but unpaid loans and interest reduce the death benefit and can cause the policy to lapse.
Is there a credit check for a policy loan?
Usually not, because the cash value secures the loan.
Can a policy loan cause my policy to lapse?
Yes, if the loan plus interest grows larger than the cash value.