You can borrow from a life insurance policy only if it’s a permanent policy that builds cash value. That means whole life, universal life, and variable life all qualify. Term life does not, because it has no cash value to lend against. The loan uses your accumulated cash value as collateral, so there’s no credit check, no application, and no fixed repayment schedule — but the balance and its interest come out of your death benefit if you never pay it back.
Whole Life
Whole life is the most straightforward policy to borrow against. A portion of every premium builds cash value at a guaranteed rate, so your borrowing power grows on a predictable path. Most insurers let you borrow up to 90% of the accumulated cash value.1Guardian Life. Guide to Life Insurance Loans It usually takes several years of premium payments before there’s enough cash value to make a loan worthwhile.
Interest on whole life policy loans generally runs 5% to 8%, and your contract sets whether the rate is fixed or variable.2New York Life. Borrowing Against Life Insurance You aren’t required to make monthly payments the way you would on a bank loan. You can pay interest only, pay irregularly, or pay nothing. Whatever balance remains, plus accrued interest, gets subtracted from the death benefit your beneficiaries receive.
Universal Life
Universal life also builds cash value you can borrow against, and the borrowing limit sits in the same range as whole life — up to about 90% of accumulated cash value.3Guardian Life. How to Borrow Money from Your Life Insurance Policy The mechanics differ, though. You can adjust your premium payments and death benefit within limits, which directly affects how fast cash value accumulates. The interest credited to your cash value can change based on rates the insurer sets, though most policies include a guaranteed minimum floor.
That flexibility carries a risk whole life doesn’t share. Your cash value has to cover the ongoing insurance costs inside the policy. Borrow a large slice and the remaining cash value may not be enough to cover those internal charges, which forces you to raise your premium payments to keep coverage in force. If you can’t or don’t, the policy lapses and you lose the coverage entirely.
Variable Life
Variable life lets you direct your cash value into investment subaccounts that behave like mutual funds, so your borrowing power rises and falls with the market. A good year can build substantial cash value; a bad one can cut it sharply. Most insurers allow loans of 75% to 90% of current cash value, but that ceiling can shift day to day as your investments move.3Guardian Life. How to Borrow Money from Your Life Insurance Policy
Because variable life contains an investment component, it’s regulated as a security under federal law and must comply with SEC requirements on top of state insurance rules.4Legal Information Institute. Variable Life Insurance When you take a loan, the borrowed amount is typically pulled out of your subaccounts, so that money no longer participates in market gains. Combined with the policy’s internal fees, borrowing during a flat or declining market can erode cash value faster than you’d expect.
Why Term Life Can’t Be Borrowed Against
Term life pays a death benefit for a fixed period, commonly 10 to 30 years, and nothing else.5Progressive. How Long Should I Have Term Life Insurance? Every premium dollar goes toward maintaining the coverage, with no piece set aside as cash value. No cash value means nothing to borrow against. That’s exactly why term premiums cost so much less than permanent life insurance — you’re paying only for the death benefit.
Many term policies include a conversion option that lets you switch to a permanent policy without a new medical exam. Once converted, the new policy starts building cash value, and eventually you can borrow from it. Conversion windows vary by insurer and usually close well before the term expires, so check the deadline early if borrowing access matters to you.
How Policy Loan Interest Works
Policy loan rates aren’t set by the open market. Most states follow a National Association of Insurance Commissioners model regulation that gives insurers two options: a fixed rate capped at 8% per year, or an adjustable rate tied to the Moody’s Corporate Bond Yield Average, with the policy disclosing how often the rate can change.6National Association of Insurance Commissioners. Model Policy Loan Interest Rate Bill In practice, most policy loan rates fall between 5% and 8%.2New York Life. Borrowing Against Life Insurance
Some insurers charge interest in advance, deducting it from the loan proceeds at origination. Others accrue it over time. The method matters. Upfront interest reduces the cash you actually receive, and accruing interest compounds against your cash value. Your policy contract also specifies whether interest compounds annually or more frequently, and over a multi-year loan that difference adds up. Read that section of the contract before signing.
Taxes on Policy Loans
One of the biggest advantages of borrowing from life insurance is that the loan proceeds generally aren’t taxable income. As long as the policy stays in force, the IRS doesn’t treat the loan as a distribution.7U.S. Government Accountability Office. Tax Treatment of Life Insurance and Annuity Accrued Interest No 1099, nothing owed at tax time.
That picture flips if the policy lapses or you surrender it with a loan outstanding. The IRS then treats the transaction as a disposition, and the taxable gain equals everything you received from the policy (including the loan proceeds) minus your cost basis, which is the total premiums you paid.8Office of the Law Revision Counsel. 26 USC 72 – Annuities; Certain Proceeds of Endowment and Life Insurance Contracts The gain is taxed as ordinary income. Policyholders who borrow for years without paying anything back sometimes find their loan balance has grown past their premiums paid, and a lapse hits them with a five-figure tax bill they weren’t expecting.
The Modified Endowment Contract Trap
If you pay too much into a policy too quickly, the IRS reclassifies it as a modified endowment contract, and that changes the tax treatment of every loan you take from it. The trigger is the 7-pay test: if premiums paid during the first seven years exceed what would be needed to fully pay up the policy with seven level annual premiums, the policy fails the test.9Office of the Law Revision Counsel. 26 USC 7702A – Modified Endowment Contract Defined If the overfunding was accidental, your insurer has 60 days to return the excess. Once the reclassification takes effect, it’s permanent.
Loans from a modified endowment contract are taxed as ordinary income to the extent of any gain in the policy, and if you’re under 59½, you also owe a 10% penalty tax on the taxable portion.8Office of the Law Revision Counsel. 26 USC 72 – Annuities; Certain Proceeds of Endowment and Life Insurance Contracts That effectively wipes out the tax advantage that makes policy borrowing attractive in the first place.
Loans Versus Partial Withdrawals
Most permanent policies also allow partial withdrawals, sometimes called partial surrenders, and the tax rules are different. Withdrawals come out of your cost basis first, so they’re tax-free up to the total premiums you’ve paid. Anything beyond that is taxed as ordinary income. Loans, in contrast, aren’t taxable while the policy is active because they’re treated as debt secured by the cash value. Loans accrue interest and withdrawals don’t, but the tax flexibility often makes loans the better tool for larger amounts.
What Happens If You Never Repay
Because there’s no required repayment schedule, it’s easy to let a policy loan sit. Interest keeps accruing, and unpaid interest gets added to the loan balance, which then generates more interest. Left alone long enough, this compounding quietly eats into your cash value.
When the loan balance approaches your policy’s cash value, your insurer will send a warning. If the balance exceeds the cash value and you don’t add funds, the policy lapses. You lose the coverage and face the tax consequences of a disposition. Some policies include an automatic premium loan feature that uses cash value to cover missed premium payments, which can accelerate the problem if you already have a separate policy loan running.
If you die with a loan outstanding, the insurer subtracts the full balance from the death benefit before paying your beneficiaries. A $500,000 policy with a $150,000 loan pays $350,000. Checking your loan balance at least once a year and making periodic interest payments, even without touching the principal, is the most reliable way to keep the policy from drifting toward a lapse.