Legal Definitions - policy loan

A policy loan is a type of loan that a policyholder can take out against the cash value accumulated in a permanent life insurance policy, such as a whole life or universal life policy. Unlike a traditional loan from a bank, a policy loan is not subject to credit checks and is essentially the policyholder borrowing their own money, with the policy's cash value serving as collateral. The loan reduces the policy's cash value and, if not repaid, will reduce the death benefit paid to beneficiaries upon the policyholder's passing. Interest accrues on the loan, but there is typically no strict repayment schedule, offering flexibility to the borrower.

Here are some examples illustrating how a policy loan might be used:

• Scenario: Sarah has a whole life insurance policy that has accumulated a significant cash value over many years. Her car unexpectedly breaks down, requiring an expensive repair that she hadn't budgeted for. Instead of using a high-interest credit card or depleting her emergency savings, she decides to take out a policy loan to cover the repair costs.
  Explanation: Sarah's action illustrates a policy loan because she is borrowing money directly from the cash value accumulated within her life insurance policy. This allows her to access funds quickly for an emergency without a credit check, and she can repay it at her own pace, knowing that any outstanding balance would reduce the eventual death benefit paid to her beneficiaries.
• Scenario: Mark owns a small consulting firm and identifies a lucrative opportunity to invest in new software that would significantly boost his company's efficiency. He needs capital quickly but wants to avoid the lengthy application process and strict terms of a traditional bank loan for his business. He uses a policy loan from his universal life insurance policy to fund the software purchase.
  Explanation: This demonstrates a policy loan as Mark is leveraging the cash value of his personal life insurance policy to secure funds for a business need. The flexibility and speed of a policy loan make it an attractive option compared to external financing, as he can use his own policy's value as collateral and manage the repayment terms himself.
• Scenario: Emily's daughter is accepted into her dream university, but a gap exists between the financial aid offered and the total tuition cost. Emily has a whole life policy that has built up substantial cash value over the years. To cover the remaining tuition without taking out a high-interest private student loan or dipping into her retirement savings, Emily takes a policy loan.
  Explanation: Here, the policy loan provides Emily with a flexible way to finance her daughter's education. She is borrowing against her policy's cash value, which means she avoids a credit check and has control over the repayment schedule, making it a convenient and potentially less costly alternative to other forms of borrowing for educational expenses.