What's the difference between simply taking out a loan and policy loan?

[Charlielor]

If my life insurance has some cash value in there, I can take out a loan against that policy. What's the difference between this and just simply go out to a local bank and taking a loan?

 

[adjusterjack]

Bank loan - Qualify with your credit score, pay interest, once you use up the money you have to pay it back to the bank and never see it again.

Policy loan - No credit check. Probably lower interest rates. And you pay the money back to yourself.

 

[Charlielor]

Thanks for the response but I'm a bit confused when you said "pay the money back to yourself" part. Let's say I borrow $50K with 5% interest against the policy. Is the $50K coming from my cash value, policy principle, or the insurer? If it's the insurer, why do I pay me back instead of the insurer? If it's coming from my cash value, that would mean I have less money to make more money for myself, correct? If it's from my policy's principle, does that mean the next time I pay my insurance premium, I have to increase that amount or make up?

 

[goillini52]

Thanks for the response but I'm a bit confused when you said "pay the money back to yourself" part. Let's say I borrow $50K with 5% interest against the policy. Is the $50K coming from my cash value, policy principle, or the insurer? If it's the insurer, why do I pay me back instead of the insurer? If it's coming from my cash value, that would mean I have less money to make more money for myself, correct? If it's from my policy's principle, does that mean the next time I pay my insurance premium, I have to increase that amount or make up?

If you die before you pay back the policy loan, the remaining balance will be deducted from the face amount. That's what he means by paying yourself/beneficiary back.

 

[LostDollar]

Thanks for the response but I'm a bit confused when you said "pay the money back to yourself" part. Let's say I borrow $50K with 5% interest against the policy. Is the $50K coming from my cash value, policy principle, or the insurer? If it's the insurer, why do I pay me back instead of the insurer? If it's coming from my cash value, that would mean I have less money to make more money for myself, correct? If it's from my policy's principle, does that mean the next time I pay my insurance premium, I have to increase that amount or make up?

Caveat, NOT an agent.

I have a whole life policy issued around 40 years ago. Most of my experience is with that.

I can NOT borrow the death benefit amount. All I can borrow is the cash value amount. Mine is a $10,000 policy. I have borrowed from it several times over the years to pay the policy's premiums.

I have also taken some small loans of $2K-$3K apiece. I did not have to put on my best necktie, sit anxiously on the edge of a chair and whine to a financial institution loan officer to do that. I just called the insurance company completed some paperwork and got the money.

The interest due for loans for the preceding year was shown on my next annual billing notice. If I had the money, I could pay the current premium and interest or I could just let them add to the outstanding loan balance (as long as the available cash value would cover it). I always eventually got my loans repaid. In years where I could not make the payment, I never had a situation where money I needed to pay in for current premium plus interest due exceeded available cash balance, I don't know what would have happened then.

If I would have died prior to repaying all of a loan balance, the remaining loan balance plus outstanding interest would have been subtracted from the death benefit my beneficiary would have received.

At least with my policy, repayment of the loan was not required at the time of my annual payment. I think the longest I had a loan outstanding was a period of 3-4 years and it worked fine for me.

Keep in mind I am talking about an old whole life policy. I don't know what differences you might face with a newer universal life policy with a different company.

I have never been clear on whether policy dividends for my whole life policy are paid on cash value including the outstanding loan balance or cash value less the outstanding loan balance. And, as I said before, I also don't know what difference universal life would bring to that situation.

 

[adjusterjack]

Let's say I borrow $50K with 5% interest against the policy. Is the $50K coming from my cash value, policy principle, or the insurer?

The cash value, assuming you had enough cash value available.

Let's say your policy has accumulated $100,000 in cash value and you borrow $50,000 and you agree to pay it back $1000 per month.

When you get the loan the remaining cash value is reduced to $50,000 and so is the death benefit.

Each month that you make a payment on the loan, the cash value and the death benefit are replenished by the amount of the payment.

That's what is meant by paying yourself back. Basically, you took a large amount of your money out of your piggy bank and you're putting the money back in a month at a time.

There is likely a mechanism in place where you pay your premiums one way and you pay back the loan some other way.

 

[adjusterjack]

I have never been clear on whether policy dividends for my whole life policy are paid on cash value including the outstanding loan balance or cash value less the outstanding loan balance.

It would have to be on only the cash value less the outstanding loan balance.

I also don't know what difference universal life would bring to that situation.

Only that the cash accumulation would be a lot less.

UL is a compromise between cheap term insurance and expensive whole life insurance. UL lowers the cost of life insurance so that more appropriate amounts can be purchased for premiums closer to term insurance and still accumulate some cash.

 

[Tahoe Ray]

It would have to be on only the cash value less the outstanding loan balance.

That's not always true.

Only that the cash accumulation would be a lot less.

Also not always true.

 

[LostDollar]

That's not always true.


Also not always true.

Thanks for the comments.

I have to admit to some embarrassment here: DHK took some time, 2-3 posts in a thread a few years back, to explain to me concepts underlying this question -- things like cash value, death benefit, and amounts at risk; and I am now unable to remember the things he said.

I thought that in some of his discussions, either answers to me or answers to others, he had made comments about situations where the total cash value of a policy was earning interest, regardless of whether or not the policy holder had an outstanding loan.

The basic thing that I have learned is that life insurance is a much more sophisticated and intricate mechanism than I can follow very well.

 

[rousemark]

The cash value, assuming you had enough cash value available.

Let's say your policy has accumulated $100,000 in cash value and you borrow $50,000 and you agree to pay it back $1000 per month.

When you get the loan the remaining cash value is reduced to $50,000 and so is the death benefit.

Each month that you make a payment on the loan, the cash value and the death benefit are replenished by the amount of the payment.

That's what is meant by paying yourself back. Basically, you took a large amount of your money out of your piggy bank and you're putting the money back in a month at a time.

There is likely a mechanism in place where you pay your premiums one way and you pay back the loan some other way.

When you get a loan, the cash value is not reduced nor is the death benefit. The insurance company loans you their money and he policy values stand as collateral for the loan. If the cash value in the policy was reduced by the loan, then it would no longer grow as illustrated.