Introduction Most of us buy an insurance policy to safeguard our family so that in our absence our family should not financially feel the pain. In general meaning, insurance is a method of financially protecting your family. But, over a period of time, its scope has widened a lot. You might have seen many kinds of policies like endowment policy which has both insurance and investment attached to it, Unit Linked Insurance Policy (ULIP), Money back policy, term policy and most recently return of premium term policy. And the scope gets further widened when you come to know that you can take loan against your life insurance policy at a much cheaper rate of interest when compared to personal loans. But such loans are available only to those policies which have a surrender or cash value. Generally, a policy will gain surrender value only when at least three annual premiums are paid.
Can I borrow money from my life insurance policy As explained above, you can borrow money from those policies which have a surrender value. That means, only endowment and money back policies are eligible to be used as collateral for your borrowed money. Sometime back, even ULIPs were also used as collateral but not now. To know the exact amount of surrender value of your policy, you may have to consult your insurer. Loan against life insurance policy has one advantage in which the surrender value won't change with the prevailing market conditions which may not be the case with shares or gold when they are kept as collateral. Their value changes with the market conditions. Generally, if the collateral value decreases with the market conditions, the lender may ask the borrower to pay the remaining margin as cash or ask to pledge more such assets as collateral in order to compensate for the margin money.
Borrowing money from a life insurance policy is very much similar to borrowing a personal loan. You can use the borrowed amount of money for any kind of purpose that you want, without giving any explanation about how you spend that money. For granting such loans, there won't be any strict approval process or any intense scrutiny method followed. But the creditworthiness of the borrower is taken into account. The income of the borrower is also not a major deciding factor while considering his eligibility. Banks as well as insurance companies provide such loans. The policyholder, who wants to borrow money, has to contact the insurance company or the bank to know more about the process and the required documents. While availing such loans, the original policy document needs to be submitted to the lender.
How much can you borrow from your life insurance policy Generally, the loan amount will be decided according to the surrender value and it may also depend on the bank or the insurance company that is providing it. It can even depend on the nature of the policy. Insurance companies in general provide somewhat higher amount when compared to banks. It can go up to 90 percent of the surrender value in case of insurance companies but banks generally provide up to 80 - 85 percent of the surrender value. When you apply for loan, there will be some processing fees as well as other charges that are levied by the banks in addition to levying the interest rate. Generally, interest rates that are charged by the banks are somewhat higher when compared to the insurance companies. Even the rate of interest may differ from one bank to the other. Once the amount of loan is decided, your policy document will be assigned to the lender. Thereafter all the privileges of the policy are taken over by the lender and only then loan is approved to the borrower.
Why borrowing against life insurance policies is gaining prominence The interest rate will be lower in case the amount of premium and the number of premiums paid are more. Flexible nature of repayment tenure along with a provision of repaying the principal loan amount at the time of claim settlement is also attracting customers, who are in despairing need of money. Generally, any loan that is taken from a bank, needs to be repaid in the form of Equated Monthly Instalments (EMIs), which include both principal as well as interest amount. However, in this case, it is optional and the customer can choose to pay only the interest amount. Another advantage is that the customers having relatively low credit scores, are not restricted to avail such loans as it is very easy to meet the eligibility criteria. In addition to that, loan is also approved within a short period of time after the submission of the application form.
What happens when unable to repay the loan It is important to repay the loan or interest amount in a timely manner. If it is not repaid, the interest gets accumulated and hence the total principal plus interest money can exceed the surrender value. In such a scenario, the lender reserves the right to surrender your policy and settle its due amount. The policyholder has to continue paying the premium even after taking the loan. If the policyholder doesn't pay up the premium, the insurer may terminate his policy or change it into a paid up one. In that case also, the lender will recover its due amount from the insurer by surrendering the policy if money is not repaid by the borrower. If any residual amount remains after the loan is recovered, the balance will be given back to the borrower or his beneficiaries.
Conclusion The biggest disadvantage of taking such loans is that in case of sudden demise of the borrower during the tenure of the loan, the surviving beneficiary will not get the insurance benefits completely. After recovery of the outstanding loan and interest amount by the lender, the remaining amount will be received by the beneficiary. So, it is of utmost importance to have sufficient life cover before taking loan against your life insurance policy. It is also not advised to borrow the maximum eligible amount but to borrow what is required. Finally, it is advised to repay the borrowed money in a timely manner so as to maximise the death benefits to your beneficiary.