Can I Use Life Insurance to Pay Off Debt?

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Updated on Tuesday, February 26, 2019

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There are many ways to pay off debt, but some lesser-known strategies could be right for your situation. One of those more obscure methods is borrowing from your life insurance policy and applying the money to your debt.

Note that not all life insurance policies allow you to do this. Standard term life policies don’t offer this feature because they don’t build up a cash value from which to borrow. They are, as the name implies, intended to provide coverage for a defined period. When that time is up, if you’re still alive, you receive no benefit.

But whole life insurance lasts for your entire life, building cash value with each premium payment you make. That cash value can ultimately be tapped for a loan if necessary.

But, before you say “sign me up,” Sa El, co-founder of Simply Insurance, a licensed insurance agency, said you must understand how the process works as well as the pros and cons. If you’re considering this as a debt payoff option, he said you should have a lengthy discussion with a life insurance professional to see if it makes sense for your specific situation and learn what will happen with your policy if you borrow from it.

What to know about borrowing from your life insurance policy

Here are some things you need to know, according to El, before borrowing from your life insurance policy:

  • It takes a long time to build up cash value since only a small percentage of your monthly premium payment goes toward the value.
  • If you take out a loan from your policy, you may pay a fee to your insurance company to process the transaction. The amount varies based on your policy or insurer.
  • Depending on your state’s laws, the cash you receive from this loan may be open to creditors that you owe (if you have a judgment, for example).

Pros of borrowing from your life insurance plan

There are a few benefits to utilizing a life insurance loan, according to El:

  • Getting the loan can be easy. If you’ve got cash value built up, reach out to your insurer to fill out necessary forms. There’s no credit check or drawn-out process, and you’ll generally have the money in a few days.
  • The loan won’t appear on your credit report.
  • You won’t have any pressure to repay the loan since there is no official due date.
  • Interest rates may be lower than other lending options (especially subprime loans), ranging from 5% to 11%, per El, depending on the insurance company.

Cons of borrowing from your life insurance plan

Conversely, El points out that there are a few downsides to taking out such a loan:

  • If you fail to pay back the loan (principal and interest) , your heirs will receive a reduced death benefit.
  • If the amount borrowed plus interest accrued ever exceeds the policy’s value, the insurer could cancel it.
  • You’re not utilizing the life insurance policy as it was intended. “Life insurance isn’t for you,” he said. “It’s for the people you’re leaving behind.”

How to avoid debt moving forward

Once you’ve said goodbye to your debt, how can you avoid getting back into financial trouble? Here are a few ways to keep your personal balance sheet in the black:

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