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Sooner or later, everyone starts considering life insurance so their family members won’t feel burdened after the policyholder’s death. Once the insurance pays out, dependents receive a predetermined lump sum of cash to help alleviate hefty fees, such as funeral and burial costs. However, did you know that the insured can use life insurance to pay off debts while still paying premiums? We're here to help you learn more.
Life insurance is a contract that states the beneficiary pays a set monthly premium in exchange for a payout once the policyholder dies. The payout replaces the income of the deceased to help keep the family financially afloat, but which type is right for you?
According to U.S. News & World Report, term life insurance provides coverage for a specific amount of time, such as 30 years, or until the insured reaches a certain age, like 65. If the policyholder does not die within that time, this temporary coverage expires, and the beneficiary doesn’t receive death benefits. It also does not accumulate interest (or cash value) over time, meaning you can’t borrow from it.
However, many consider it for the lower premium, which makes it a cost-effective option. Some policyholders also like it for temporary coverage while their kids are young. That’s because, by the time the coverage expires, their children will become self-sufficient adults and won’t be dependent on the beneficiary or need monetary support for emergencies or college.
Universal or whole life insurance, however, is permanent coverage that lasts the insured’s lifetime. Because coverage doesn’t end, this life insurance type comes with guaranteed death benefits and predictable premiums. If the policyholder pays their premiums regularly and on time, the policy develops cash value that they can then borrow from the way they would any other lender.
The only money you put into your insurance policy comes from your premiums. According to Forbes, each premium payment goes into:
If you use your life insurance to pay off debts, you would use money from the cash value. While your cash value may not be high when you first obtain your policy, it earns tax-deferred interest, which (as Investopedia says) grows within the following decades.
For instance, if you have a policy with a face value of $100,000, you won’t have cash value at first, but after about 20 to 30 years, your cash value can increase 50%, leaving you with $50,000. After another five to 10 years, the cash value accumulates to about $75,000.
In this case, if something were to happen to the insured, the insurance company would only pay $25,000 out of pocket, and the rest of your payout would come from the cash value you earned. However, depending on the policy type and the monthly payments you make, cash value can ascend faster or slower, sometimes even transcending face value. But what amount can you borrow at a time from it and how?
Unlike getting a loan from a bank, you don’t need to undergo a credit check (or worse yet, fail it) when you borrow from your whole or universal life insurance. Borrowing from life insurance saves you time and energy since you don’t even have to leave your home to obtain the loan. Simply call the insurance agency and verify you have the appropriate insurance policy that accumulates cash value.
Once verified, let them know of your plan to borrow from it and they’ll email you an “in-force illustration” statement that outlines your current cash value and its projected rate for the future. It also relays how much you’re able to borrow so you can fill out a “Policy Loan Request” form with your desired amount, along with personal information like your name, address, and social security number.
After signing and returning the form to the provider, the company sends a check in the mail within the next week. In most cases, the carrier allows borrowing rates of up to 90%, with very few allowing you to take out the full 100% of the available cash value. However, we warn against doing so since, like a traditional loan, you eventually have to repay the total amount.
Debt settlement with life insurance is simple since you can use the money to pay off any loans, bills, mortgages, and other outstanding fees. Some examples include but are not limited to the following.
If you have a mortgage on your home, you likely have a co-signer who is in charge of paying the remainder of the debt in case something happens to you. If something does happen, they can use your life insurance to pay off debts to keep the home when the mortgage falls to them. However, if you feel prematurely receiving funds is necessary to make your next payment, you can borrow from your cash value now.
Using life insurance to settle debts like student loans is also possible. While student loans usually disappear for the borrower and co-signer if the borrower dies, a child who relies on your income to repay their debts can use the insurance payout to cover costs after you die. Even though the child cannot borrow from your cash value while you’re still alive, you can do so to give them the money they need.
Similarly, a business partner can use your life insurance to pay off loans related to your company after your death, or you can borrow from your policy, making that your no-hassle business loan.
While authorized users are not responsible for paying leftover credit card debt after you die, a cosigner or joint account owner is. So, offer them financial security for debt repayment by having insurance. Like in all the above cases, you can also use the cash value to help you during months when you can’t meet your minimum payment balance.
Since no two borrowers, insurance policies, or situations are the same, consider the benefits and drawbacks of borrowing against your cash value to determine whether it’s the right decision for you.
Some of the immediate benefits of paying debts with life coverage are no application fees or credit checks, which speeds up the process and increases your chances of obtaining funds. For instance, if you have outstanding credit card costs and don’t qualify for a debt management program or loan, using your life insurance's cash value helps. You also don’t have to answer questions or receive approval for what you’re using the funds for.
Since you’re borrowing from yourself, in a sense, you also have a more lenient repayment plan. If you’re unable to repay some or all of the total amount, you can rest easy knowing a bank or credit union isn’t coming for your assets. The provider simply reduces your death benefits to compensate, which means if you borrowed $15,000 from your cash value, you’ll receive that much less once the insured dies.
Other benefits of clearing debt with life insurance include the following:
If you’re considering using life insurance to pay off debts, remember that term life doesn’t offer cash value, which leaves these policyholders without borrowable funds. Only the insured can borrow, meaning spouses, children, and other relatives cannot take out funds. Other cons include:
Now that you know whole life insurance comes with cash value that you can use to your advantage, trust us to determine which policy is right for you. At Insurdinary, our team stays on top of recent and relevant policies so we can match you with the one that best suits your needs and preferences. So, contact us to learn more about how to use life insurance to pay off debts and receive an insurance quote today!