You can take a loan on some types of life insurance policies

If you are cash strapped and in urgent need of money, you can take loan against your life insurance policy

If you are cash strapped and in urgent need of money, you have the option of turning to your life insurance policy for help—you can take a loan against it. But what kind of policy and how much loan can you take? Let’s find out.

Policies that have an underlying value are eligible for a loan. So a regular term insurance policy does not give a loan, but insurance-cum-investment plans do. However, regulations bar unit-linked insurance plans (Ulips) from giving loans. Traditional plans such as endowment and money-back plans are eligible for a loan.

You can’t take a loan on the first day of having bought the policy but only once the policy has acquired a surrender value. Typically, in traditional plans, the policy acquires a minimum guaranteed surrender value after 2-3 annual premiums have been paid. For instance, if the premium payment term is at least 10 years, then the policy acquires a surrender value after three annual premiums are paid. At first, the surrender value is 30% of the total premiums, and it gradually increases every year.

The insurer gives you a loan against the surrender value. Typically, the insurer will give you 70-90% of the surrender value as loan. At this point it is important to know that there are two types of surrender values. One is the minimum guarantee surrender value as stipulated by law, and the other is a special surrender value, which indicates the value of your investments.

Although initially there is little difference between the two, after some time, the special surrender value is usually higher than the minimum guaranteed surrender value. Insurers offer loans on the higher surrender value.

At present, the rate of interest on a loan on a life insurance policy is 8-10%. You need to pay the interest at least every year. You can keep the loan going till the policy term and you have the option to either pay up the principal amount or have it adjusted from the maturity corpus or death benefit payable to beneficiary.

If you default on payment, then as long as the policy is active (you are paying your premiums on time) and the surrender value is higher than the principal plus accumulated interest, the loan continues. Thereafter, the policy is foreclosed and the insurer recovers its dues.

According to a financial planner we spoke to, such a loan makes sense if the individual’s credit worthiness is low or if the personal loan is at a much higher rate. However, since the loan amount is simply a percentage of the surrender value, keep in mind that what you finally get from the insurance company may not be a large amount.