Your Comprehensive Guide to Loan Against Life Insurance

When facing a financial emergency, individuals often consider taking out a Personal Loan or using their credit card. However, a life insurance policy, originally designed to provide financial security to beneficiaries in the event of the insured's passing, can also serve as collateral for availing of a loan during times of financial hardship. Despite a recent surge in the number of people using Loans Against Life Insurance Policies, a significant number of people remain unaware of this option or lack a clear understanding of how it functions. To address these concerns and provide comprehensive clarity on the concept of a Loan Against a Life Insurance Policy, we have compiled this comprehensive guide, which serves as a one-stop solution for all your doubts regarding this financial tool.

What is Loan Against a Life Insurance Policy?

A Loan Against a Life Insurance Policy allows the borrower to take a loan by using their life insurance policy as collateral with the insurance company. If the borrower fails to repay the loan within the specified timeframe, the company holds the right to retain the policy until the debt is fully repaid.

Which life insurance policies are eligible for the Loans Against Life Insurance Policies?

According to the guidelines set by IRDAI (Insurance Regulatory and Development Authority of India), Unit Linked Insurance Plans (ULIPs) and Term Insurance Policies do not offer a loan facility. Only traditional insurance policies like endowment, money-back policies, and similar types are eligible for loans. Nevertheless, it is essential to review the terms and conditions of your specific insurance policy and inquire about its eligibility for the loan facility.

Furthermore, to be eligible for a loan on an insurance policy, the policy must have acquired a surrender value. Typically, the loan amount sanctioned is around 85% to 90% of the policy's surrender value.

Join Now: PersonalFN is now on Telegram. Join FREE Today to get 'Daily Wealth Letter' and Exclusive Updates on Mutual Funds

What are the features of a Loan Against a Life Insurance Policy?

• The interest rate for a Loan Against a Life Insurance Policy varies based on the applicant's profile and the lender's policy. Compared to unsecured loans, the interest rate for a Loan Against a Life Insurance Policy is relatively low. Traditional Personal Loans typically have interest rates ranging from 11% to 16%, while loans obtained through a life insurance policy carry interest rates of 10% to 12.5%.

• To avail of a loan, the applicant must surrender their life insurance policy to the lender, bank, or insurance company. The loan amount is provided as an advance against the policy's surrender value. .

• This type of loan is exclusively available to individuals who hold a traditional life insurance policy. It cannot be availed of against the term insurance plans. .

• The loan amount is determined by the surrender value of the life insurance policy, i.e. up to 85% to 90% of its value. .

• If a borrower defaults on the loan, he/she will not receive the maturity amount of the policy as the policy serves as collateral and will be terminated. This occurs when the outstanding loan debt exceeds the surrender value of the policy. .

• If the policy reaches maturity before the loan is fully repaid, the insurance company deducts the outstanding loan amount from the maturity amount. The remaining balance is then given to the policyholder. .

• A Loan Against a Life Insurance Policy can be beneficial for individuals with a low credit score, although having a good credit score can potentially lead to a lower interest rate for this type of loan. .

• As the applicant already holds a life insurance policy, which serves as collateral, additional documentation to prove eligibility for the loan is not required. Basic KYC documents such as identity cards and proof of residence are sufficient. However, the original life insurance policy must be submitted to the lender, along with a letter consenting to the terms and conditions of the lender, bank, or insurance company. For loan application updates, providing contact information like mobile numbers and email addresses is also necessary. .

What are the benefits of taking a Loan Against a Life Insurance Policy?

1. Lower interest rates: One of the significant benefits of the Loans Against Life Insurance Policies is the comparatively lower interest rates offered when compared to other financing options.

2. Quick disbursal: Due to minimal documentation requirements, the loan is disbursed quickly, with streamlined application processes.

3. Instant approval: Based on the surrender value of your policy, you can receive instant loan approval. This allows you to access a maximum loan amount of approximately 85% to 90% of your policy's surrender value.

4. Reduced chances of rejection: As you provide a life insurance policy as collateral/security, the likelihood of your loan application being rejected is lower compared to unsecured loans.

How to get a Loan Against a Life Insurance Policy?

• You should contact the insurance company from which you purchased the life insurance policy to inquire about the same. .

• Once confirmed that the loan can be availed, it is advisable to gather information about the maximum loan amount that the company offers to policyholders. Typically, the loan amount depends on the specific type of life insurance plan and the remaining term of the policy. .

• If the loan facility aligns with your requirements, submit a loan application along with the required documents to the insurer. This process involves assigning the policy to either the insurer or the bank providing the loan against the life insurance policy. By assigning the policy, all rights to the policy are transferred to the insurer or bank for the loan's duration. .

• The lender will require you to provide comprehensive policy details and specify the loan amount using the designated format provided by the insurer or bank. .

• You will be required to pay the loan processing fee and any other relevant charges, to the bank. .

• After a thorough review of the policy details and necessary documents, the insurer or bank will approve the loan within 2-3 working days. However, take note that the timeframe may vary from lender to lender. .

• Once the loan is approved, the borrower will receive the loan amount, and all policy rights will be automatically transferred to the lender. The policy will be reassigned to the insured individual through an endorsement after the loan amount is repaid.

What are the documents required for a Loan Against a Life Insurance Policy?

1. Loan Application Form: A duly filled and signed loan application form with the necessary information, such as personal details, residential address, banking information, and contact details.

2. Original Life Insurance Policy: The borrower is required to submit the original document of their life insurance policy, which serves as collateral for the lender.

3. Signed Loan Agreement for Policy Assignment: The borrower must sign a loan agreement stating that they are assigning their life insurance policy to the lender as collateral for the disbursed loan. This ensures that the policy can be held as collateral by the lender or bank.

What if you are unable to make the repayment?

In case you are unable to repay the loan, the accumulated interest will continue to increase the outstanding balance. If the loan amount surpasses the surrender/cash value of your insurance policy, it can lead to a policy lapse. In such cases, the insurer has the right to recover the loan amount and interest from the policy's surrender value and may terminate your insurance plan.

To conclude:

It is advisable to opt for a Loan Against a Life Insurance Policy only during emergencies. Once you have taken the loan, it is crucial to prioritise timely repayment in order to minimise the amount of interest paid. Furthermore, it is important not to neglect to pay your insurance premiums on time, as this can have adverse consequences. In the unfortunate event, such as death, failing to pay premiums may jeopardise the financial well-being of your loved ones. Given the uncertainty of life, it is essential to approach each decision with prudence and foresight.

Also, take note that while a life insurance policy provides essential protection, the loan facility is a valuable additional feature. However, before considering this type of loan, it is crucial to thoroughly review the terms and conditions set by the lender to avoid any discrepancies when applying for a loan against an insurance policy.

KETKI JADHAV is a Content Writer at PersonalFN since August 2021. She is an MBA (Finance) and has over seven years of experience in Retail Banking. Ketki specialises in covering articles around banking, insurance, personal finance, and mutual funds and has been doing it for over three years now.

Disclaimer: Investment in securities market are subject to market risks, read all the related documents carefully before investing.

Disclaimer: This article is for information purposes only and is not meant to influence your investment decisions. It should not be treated as a mutual fund recommendation or advice to make an investment decision.