A life insurance policy is designed to provide a protective cover. However, life insurance is a far more versatile option nowadays. While they are primarily aimed at providing financial cover for the family in case of the death of the breadwinner, insurance policies can also be used to raise money for urgent needs. At times, one may need to take a loan when a financial emergency comes up. In such a situation a personal loan is one of the quickest options. But is it the best option? Instead of going for an expensive option like a personal loan, there is another option you can consider. This is taking a loan against a life insurance policy. So, not only does it provide security, but it also helps when one is going through a cash crunch.

What is a loan against an insurance policy?
A loan against an insurance policy is an arrangement where a borrower can avail loan by pledging their insurance policy as collateral with the insurance company. If the borrower is unable to pay back the loan on time, then the company reserves the right to hold on to the policy until the debt is realized in full.

Which insurance policies are eligible for a loan?
You cannot avail of loans against every type of life insurance policy. Therefore, it is better to check with your insurance company before buying any plan. Policies such as whole life policy, money-back policy, and endowment plan provide a loan against a life insurance policy. However, such loans are not available against term insurance policies and unit-linked plans. (This does not mean you do not take term insurance policies. The use of insurance is to protect your loved ones after you are gone, hence, a term insurance policy is a must)

Eligibility
When borrowing a loan against an insurance policy, you are essentially borrowing from yourself. You can thus borrow the money for any kind of expenses without having to provide an explanation, and you do not have to undergo intense scrutiny or a stringent approval process. Though the income of the borrower is also not a deciding factor for deciding the eligibility, the creditworthiness is considered nevertheless.

How much loan can I get against my insurance policy?
You can get a loan against an insurance policy starting at Rs 2 lakh, and up to 80% of the surrender value of the policy you pledge. Surrender value is the amount that a policyholder gets if he/she decides to exit the policy before maturity.

On what basis is the interest charged?
The interest rate charged in the case of a loan insurance policy is based on the premium already paid and the number of premiums that have been paid, the more the premium amount and the number of premiums paid, the lower the rate of interest charged. Usually, the interest rates are charged around 10% p.a., for loans taken against insurance policies.

What are the documents required?
To avail of this loan, a policyholder will have to submit:

  • A loan application form
  • The original insurance policy document along with your address proof, ID proof, and income proof
  • 'Deed of Assignment’ which will assign your insurance policy in favor of your lender
  • A copy of a canceled cheque
  • Payment receipt for the loan amount

What happens if you fail to repay?
If you fail to repay the loan taken against your policy, then the interest will keep adding to the balance amount. If the loan amount exceeds the insurance policy’s surrender/cash value, then this can become a reason for your policy lapse. The insurer can recover the loan amount and interest from the surrender value of your policy and may also terminate your insurance plan.
Be extremely careful when you are choosing this option, do not take a loan on an insurance policy if you know you won't be able to repay it. In this case, you will lose all the benefits of the policy.
Note: In the event of a policy lapse, taxes must be paid on the cash value.

Conclusion
Note that when you opt for a loan against the life insurance policy, like any other secured loan, the collateral is assigned to the lender. This means that the lender has the right to deduct the interest and principal amount in case of the death of the policyholder. This could compromise the financial security that you had placed in mind for your family. Therefore, before you plan to avail of such loans, make sure to go through the terms and conditions of the lender to avoid any discrepancies at the time of applying for a loan against an insurance policy
Ideally, opt for such a loan if the loan has a short tenure and you are unable to seek an alternative source of borrowing. You may also opt if you have a term insurance policy in place to secure your loved ones' future.