NEWS
What is a loan against policy and how does it work?
A loan against policy is a financial instrument that allows you to borrow money with your life insurance policy as collateral. This feature is offered with some life insurance policies, particularly classic plans such as endowment or whole life policies that have a savings or investment component.
It enables policyholders to access the full value of their coverage without surrendering it. In India, this form of loan is a popular option to get cash fast for immediate requirements while leaving your life insurance coverage intact.
What is a loan against policy?
If you take a loan on a life insurance policy, the insurer or a financial institution gives you the amount of money on the surrender value of the policy. The surrender value is the amount of money that will be paid by the policyholder if he terminates the policy before maturity.
A loan against policy is different from other loans, it has lower interest rates and less documentation. You can also repay the loan over time and the life cover continues to remain in force so long as premiums and loan repayments are paid up to date. What is a loan against policy?
How does a loan against policy work?
1) Eligibility
Not all life insurance policy loans are available. Only those with an investment or savings component, like endowment and whole life insurance policies, qualify. Over time, these policies build a surrender value that is used as collateral for the loan.
In contrast, term insurance plans are only for life coverage without a savings component and don’t have a surrender value or a loan option. If you don’t know whether your policy is eligible, contact your insurer or read your policy document.
2) Loan amount
It is determined by the surrender value of the policy. Also, the surrender value is the amount payable to the policyholder if the policy is terminated before maturity. Lenders normally provide a loan of 70 per cent to 90 per cent of this value.
Suppose your surrender value in your policy is ₹5 lakh. In that case, you can avail of a loan of up to ₹4.5 lakhs. It depends on the insurer or lending institution’s terms, but generally, the exact percentage. Remembering that taking a higher loan amount may cut the benefits of the policy, borrowers should remember.
3) Interest rates
The interest rate of loans against policies is lower than unsecured loans like personal loans or credit card advances. The interest rates lie between 8% and 12% depending on the lender and the policy.
Since the loan is secured by the policy, lenders feel that they have less risk and that translates into cost savings for borrowers. That makes it a great choice for those who need affordable borrowing for emergencies or short-term needs.
4) Application process
The process of taking a loan against the policy is very simple and hassle-free. The first thing you need to do is contact your insurer or a bank that accepts insurance policies as collateral. Fill in the loan application form and attach your policy document.
Identity proof and address proof may be additional documents required. The loan is processed and disbursed once the insurer confirms the surrender value. The policy acts as collateral and this process are normally quicker than that for other loans as there are no extra steps involved.
5) Repayment flexibility
The flexibility in repayment of a loan against the policy is one of the major advantages of a loan against the policy. The loan can be repaid by the borrower in regular EMIs or in one lump sum.
In this case, however, if the loan is not repaid, the outstanding debt including accrued interest is deducted from the maturity or death benefits of the policy. It’s all the more important that you repay on time to retain the full benefits of the policy for your family.
6) Life cover continuity
The life insurance cover continues even after taking a loan. By doing this, your family will be financially safe from your untimely demise.
But if the amount of the outstanding loan at the time of death is deducted from the death benefit and disbursed to the nominee. If you are paying loan repayment and policy premium, then you have to pay the policy premium otherwise your coverage will be interrupted.
7) No credit score impact
Your credit score is not usually affected because the loan is secured by the insurance policy. The policy’s surrender value is what lenders are interested in, not your credit history.
For individuals with a poor or low credit score, this is an excellent option to get funds. Failing to pay off the loan can affect your financial status with the insurer or lender.
8) No penalty for early repayment
Almost all lenders offering loans against policies do not charge any penalties for early repayment. If you have extra money, you can repay the loan before the tenure is over saving interest.
It allows borrowers to deal with their finances better and lowers the weight of debt. That’s a big advantage over many other types of loans that charge prepayment fees.
9) Tax implications
The loan against the policy is not taxable under the Income Tax Act. Unlike home loans and education loans, interest on such loans cannot be claimed as a deduction.
However, the amount of the loan is not considered taxable income, which makes for a neutral tax impact. It’s important for borrowers to take this in when comparing it to other borrowing options.
10) Policy ownership
The policy document, or the collateral, is with the insurer or lender during the loan tenure. You keep the policy but pledge its benefits to the lender.
When the loan is repaid, you own 100 per cent of the policy. This means that if you pay your repayments the policy’s life coverage and maturity benefits remain intact.
Ending note
A loan against the policy is a straightforward and effective way to obtain cash in times of need without jeopardising your life insurance coverage. It provides cheaper interest rates, more flexible repayment alternatives, and faster processing.
However, it is critical to understand the terms and circumstances, particularly the impact on insurance benefits if the loan goes unpaid. By managing your life insurance policy carefully, you may efficiently handle financial crises while ensuring your family’s future security.
