In India, life insurance policies are often marketed as investment products. While they are primarily aimed at providing a financial cover for the family in case of death of the bread-winner, insurance policies can also be used to raise money for your urgent needs.
Life insurance policies from LIC or any other reputed insurer are accepted as collateral against loans by lenders. However, only unit-linked plans (ULIP), endowment plans, whole life plans and income plans are eligible and not a term insurance policy.
Further, one is only eligible to avail loans on non-term plans where timely payments towards premiums were made for at least three years.
One can seek a loan for up to 80 percent of the surrender value of the policy pledged. Surrender value is the amount that a policyholder gets if he/she decides to exit the policy before maturity.
- The maximum amount that you can seek as a loan against the policy can go up to 90 percent of the life insurance policy’s surrender value. This gives you the option to get a rather large amount than what a loan without security would fetch.
- Interest rates charged on loans against life insurance policies are lower than what is charged on personal loans.
- While only your insurance company or bank will guide you on the documents required to apply for these loans, the documentation process isn’t as tedious as a personal loan application.
- These are ideal for emergency funding needs as they are processed faster due to the presence of a collateral as security against non-repayment. Some lenders also allow online applications.
- You can only apply for a loan against an insurance policy after you have promptly made all premium payments to acquire a surrender value. This means that for the first three years of the policy, you do not have to option to apply for such a loan.
- The applicant will have to make payments towards the loan repayment as well as the future premiums of the insurance policy to prevent the policy from lapsing.
Repayment of loan
- During the term of the policy, the applicant is required to commit to repayment of the loan as well as make premium payments. One can choose to pay the principal along with the interest or just the interest amount.
- If the borrower chooses to only pay the interest, the due principal amount at the time of settlement will be deducted from the claim amount of the policy by the insurance company.
- At the time of death of the insured during the loan term, the pending amount of the loan will be deducted from the claim amount and only the remainder will be paid to the nominee.
- On failure to repay the loan on time, the interest on loan will keep adding to the loan amount balance and exceed the policy’s cash value. This will cause the policy to lapse and will require payment of taxes on cash value.
- In case of failure to repay the loan, the amount will be taken from accumulated surrender value of the policy and the life insurance policy will be terminated.
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 death of the policyholder.
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.