A policy loan refers to a loan borrowed against a life insurance policy which has accumulated cash value.
There are typically 3 types of life insurance policies offered by insurers in Singapore:
- Term life
- Endowment
- Investment-linked
Term insurance does not accumulate any cash value and is therefore not eligible for policy loans.
Endowment policies and investment-linked policies are structured to accumulate cash value and usually comes with policy loan features that can be used by policy holders to obtain a loan against the cash value.
This allows people to borrow from themselves to get access to funds that are tax-free, maybe to alleviate cash flow problems, without having to cancel their life policies.
The loan that is approved depends on the cash value amount and and go up to 90% of the cash value.
This cash value usually does not start accumulating immediately as a policy commence.
A policy for example, might only start accumulating cash value after two years into it.
This is because the premiums paid during these times go towards beefing up the indemnity benefit.
What is cash value?
The essence of life policies are that beneficiaries would receive a lump sum cash payment upon the death of the insured individual.
Cash value is a feature of permanent or whole life insurance that promises that a beneficiary would receive a certain amount of cash should the policy be terminated prematurely.
This provides more assurance for clients to purchase such policies with lesser risks as they can be assured that they can get a certain amount of money back for signing up.
The more premiums are made to maintain the policy, the more cash value accumulates.
However, do not expect the account to resemble a savings account where every $100 deposited would raise the balance by $100.
Insurance companies get their cut and assigns a portion towards the cash value.
Depending on the nature and structure of the policy cash value can also fluctuate, especially when they are pegged to the performance of investment funds.
So cash value might not be a guarantee like a sum assured.
When they are guaranteed the amount would usually depend on various factors such as the death benefit, age and gender.
Features of life insurance policy loans
Unlike personal loans or other types of term loans offered by banks to consumers, a life insurance policy loan does not put the borrower through a stage of credit assessment to determine whether it can be approved.
A policy loan is an entitlement written into the policy which policy holders can activate.
It is a feature that can be triggered as long as certain criteria are met.
Some of which might include.
Minimum loan amount
This is a term that stipulates that the loan amount must meet a minimum such as $200.
This means that if the policy allows the policy holder to loan 90% of the cash value, then the cash value must have at least a balance of $223 accrued.
Otherwise, the borrower will have to give up on the loan.
The implication of this also means that if a borrower only initially intended to borrow 50% of a $223 balance, the request would be declined by the insurer as the amount of $111.50 ($223 x 50%) is below the minimum level of $200.
The policy holder would then have no choice but to borrow 90% at $200 if the policy loan is to go ahead.
Interest rate
As a policy loan is essentially a loan, it would inevitably come with interest rates.
The policyholder cannot withdraw the money for use and deposit it back to the account without incurring some type of financing charges.
The good news is that this is a secured loan with the cash as collateral.
So one can look forward to interest rates that are at comparable levels as unsecured credit such as credit cards.
Interest rates usually don’t go above 7% on an annual basis.
Repayment
Insurers usually allow borrowers to fully repay the loan without incurring any early repayment penalties.
So as soon as a borrower has the funds to fully settle the loan, he or she can do so and have the policy revert to where it had originally been before the loan was issued and disbursed.
On top of this flexibility with full repayment, policy loan repayment structures can also be very flexible in how it should be repaid.
Failure to repay
Should the borrower fail to repay the policy loan, then the outstanding balance plus interest could be deducted from the total death benefit.
And if interest is allowed to build-up such that the loan principal plus interest exceeds the cash value on the policy, then the policy might be terminated.
Should you take a policy loan?
The benefits of taking a policy loan against the cash value of your life insurance policy can be very attractive compared to consumers loan offered by financial institutions such as banks.
Personal loans for example, come with monthly repayment debt obligations, high interest rates, and several types of fees like those for late payment fees and administrative charges.
Loan quantums are also based on personal income.
Policy loans are easy to obtain as long as there is considerable cash value accumulated, have flexible repayment terms, significantly lower interest rates, and can be repaid anytime you have the funds without being liable to pay redemption penalties.
Policy loans also do not put the benefits of the life policy plan at risk as long as the full repayment is made according to the terms of the agreement.
But just like any types of secured loans, borrowers always put the assets that are pledged as collateral at risk.
For example, home loans are basically loans granted that are secured against the house that is being financed. And should the borrower finds himself or herself in default, the lender can exercise the legal right to repossess the property and liquidate it to pay themselves.
While policy loans against the cash value of a life policy does not result in repossession, defaults on repayment can still put the policy at risk of termination.
But this has a low likelihood as long as there is considerable cash value in the policy.
Except in extraordinary circumstances, there would most probably be enough cash value to prevent termination since one can only withdraw a certain percentage of the cash value as a loan.
This almost always means that there would be enough cash value to offset any policy loan that has not been repaid.
In that case, the policy still remains in force, just that the benefits would be compromised.
In view of the lesser risk of policy loans compared against other types of commercial and consumer loans, should one be short of cash and policy loans are an option, it would be a prudent choice to sign up for them instead of going to a bank.
