Is It A Good Idea To Take a Loan against Your Insurance Policy?

Is It A Good Idea To Take a Loan against Your Insurance Policy?

There is no doubt that insurance policies can sometimes double up as assets, enabling you to take loans against them to meet varying financial requirements. Can you go for a loan against your insurance policy? Is it the right thing to do? That is what you need to gauge, keeping several pointers in mind. Here are some valuable insights on this aspect.

What is a loan against an insurance policy?

Applying for a loan against your insurance policy means using the latter as a form of security. You can thus pledge your policy like any other financial asset to get the loan sanctioned from the financial institution. The operational mechanism is quite similar to getting a loan against your property.

If you have paid your premium for three years in succession without missing out on any payment, you will be eligible for getting a loan up to 90% of the policy’s surrender value. At the same time, these loans are only available for those policyholders who have taken whole life, endowment, or money-back policies.

Suppose you have an endowment policy against which you want to take a loan. Now you have to work out the surrender value first. This can be calculated by the total premiums you have paid minus the surrender charges imposed by the insurance company. Let us assume that you have paid Rs. 1 lakh in premiums annually over three years, i.e. Rs. 3 lakh and the surrender charges work out to Rs. 10,000. In this case, the surrender value will be Rs. 2,90,000. If the financial institution sanctions 90% of the surrender value, you will be eligible for a loan of Rs. 2,61,000 (90% of Rs. 2,90,000).

Loans cannot be availed against ULIPs (unit-linked insurance policies) and term insurance policies.

Some vital aspects of loans taken against insurance policies

  • For loans against insurance policies, any extra assets or collateral are not needed
  • The insurance policy is the guarantee for the financial institution or bank in this case
  • The rate of interest on the loan may be comparatively lower than personal loans if the insurance policy works as collateral
  • Since it is an advance that is paid against the maturity proceeds of the insurance policy, financial institutions will not take CIBIL scores or creditworthiness into the equation while sanctioning the loan
  • You will only require your KYC and income documents along with your bank statements for these loans

These loans are considered suitable for those individuals who do not possess proper documents for taking conventional loans from financial institutions. In addition, these loans also help those with lower credit scores, who find it tough to get loans (especially at reasonable interest rates).

The provision for adjusting the amount borrowed from the maturity proceeds of the policy may help those who face financial difficulties in the future. In some cases, customers may also make payments of just the interest while subtracting the principal from the future maturity amount, as mentioned. Repayment tenures are also quite flexible for these loans. Not every insurance company or bank will be sanctioning loans of 90% of the surrender value. It will depend on the lender. Therefore, you should pay heed to this aspect carefully before you apply.

Issues with loans against insurance policies

You should be doubly careful when applying for a loan against your insurance policy. The policy is otherwise meant to offer financial safety for your family members in case you are not around in the future.

You may take a considerable risk if you only repay the interest amount and leave the principal amount deducted from the maturity proceeds. As a result, a financial strain on your family may arise in case of your unfortunate demise within the policy period. Furthermore, since the pending dues will be subtracted from the maturity amount that will be paid to your beneficiaries, the nominees will not get the full benefits promised by the policy.

Furthermore, not being able to repay the loan taken on the insurance policy means the continued accumulation of interest on the pending sum. If this amount surpasses the insurance policy’s cash value, then your coverage may become invalid. The insurance company may also terminate your policy and take steps to recover the amount with interest. Hence, it is crucial to keep these potential issues in mind before you apply for any such loan.

What should you do?

The ideal course of action would be to avoid taking a loan on your policy, at least in its initial years. The available loan amount will also be smaller in the first few years. Once you have deposited a sizable premium for some years, the eligible sum as your loan will naturally increase.

Adhere to the three-year waiting period after buying your insurance policy before you apply for your loan. Even if you take this loan, repay both the principal and interest every month without keeping the former for deduction at the conclusion of the policy period. These are some steps you should take to lower potential risks to your insurance coverage, as mentioned above.

 

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