What is something that give you returns after you pump in a lot of money? Life insurance policies with cash value come to mind.
But did you know that you can actually take a loan on your life insurance? But… should you?
Wait… life insurance policies give you money?
Okay, first there are three types of life insurance every Singaporean should understand. They are term life insurance, endowment policies, and investment-linked policies. Very, very simply, here are the differences:
- Term insurance gets you the most coverage for the least cost, but you don’t get anything in return.
- Endowment policies are insurance policies that also have a guaranteed return at maturity.
- Investment-linked policies are insurance policies that also double as investments. So not only do you have a guaranteed return at maturity, there’s a chance that you might get more than the guaranteed return.
Still blur? Let’s oversimplify it with an analogy. Insurance is like a car.
Term insurance is like renting a car – you pay for what you use, but you never own the car. An endowment policy is like buying a car – you pay more than if you rent, but the car is yours. Investment-linked policies are like driving with Grab – you own the car, and if you want, you can use the car to make money.
Life insurance cash value — When can I get back this money?
Well, you don’t get back any money with term life. But with endowment policies and investment-linked policies, there is a maturity date.
This is usually between 10 and 20 years. If you die (or suffer from total permanent disability or critical illnesses, depending on the policy) before the maturity date, your dependents will get a payout. If you survive till the maturity date, you get the payout.
Wah, have to wait so long? What if I need money now?
If you need money urgently, and you have a life insurance policy, you can actually take out a life insurance loan. This is also known as a policy loan.
How does a life insurance policy loan work?
Now, with life insurance, you have something known as a cash value. This cash value is basically how much you’ll get back if you choose to cancel the policy. That means the cash value will increase over time, as you pay more premiums.
A life insurance loan borrows money from the insurance company using the policy’s cash value as collateral. Instead of cancelling the policy and taking the money, and losing out on any future benefits, you just loan that amount, with interest. In other words, and I’m oversimplifying here, it’s like borrowing from yourself.
How much can you get from a life insurance loan?
Most insurance companies allow you to borrow up to 90% of your cash value and there is usually a minimum sum involved, such as $100. Remember that this cash value is based on the premiums you’ve already paid, and not the amount you can expect at maturity. You can’t borrow from your future self.
When can you get it and how?
Depending on the amount, you can make an urgent request to get your loan within hours in the form of a cheque. Otherwise, it will take up to 6 days to issue a cheque or directly credit your bank account.
What is the interest rate charged on this loan?
Depending on the insurance company, the interest rate is anything between 5% and 7% per year.
However, be sure to check how interest is calculated. Usually, it’ll be compounded on an annual basis. If it’s compounded on a daily basis, you should turn around and walk out the door as soon as possible, unless you’re planning to strike 4D or Toto in the near future, or you know for sure that you will have the money ASAP to repay.
How does a life insurance loan compare to personal loans?
At 5% to 7% interest per year, a life insurance loan is cheaper than most personal loans (the lowest EIR right now is 7%). Not only that, but life insurance loans give you a flexibility of repayment that personal loans cannot.
By that, I mean that most personal loans require you to pay back a fixed amount monthly, and you will be penalised if you make full repayment early. That’s right, if you actually have the money and want to repay the loan early, you’ll get charged more. Life insurance loans don’t have that silly condition.
However, because the amount of a life insurance loan is based on your policy’s cash value, there is a chance you may not be able to loan as much compared to a personal loan, which depends on your monthly salary.
Life insurance loans sound great! How will taking a policy loan affect the actual insurance plan?
Whoa whoa whoa… before you go out and start taking out a loan, make sure you’re aware of these consequences:
- If your loan and interest together exceeds the cash value of the policy at any time, your policy may be terminated. This is usually not a good thing – as the whole point of the policy is for it to mature or at least provide coverage in the event of death or total permanent disability.
- Because there’s no fixed monthly repayment schedule, the insurance company has the right to change the interest rate at any time.
- Interest charges can be steep, and any unpaid amounts will be offset from the policy’s cash value or claim payout.
At the end of the day, if you’re going to be paying the higher premiums for an endowment policy or an investment linked policy, you should at least know that you can get something out of it if your cash flow is affected. Life insurance loans provide a relatively convenient and cheap means of borrowing money, but always consult your financial advisor before you make a decision to do so.
Although it has some benefits over a personal loan, it should still be used as a last-resort measure. You should always re-evaluate your finances to see if you’re spending above your means and make lifestyle adjustments if so.
Is there more that you would like to know about life insurance loans? Let us know.