What are the Possible Shortcomings of Loan Against Life Insurance Policy?

Last Updated : May 6, 2020, 3:17 p.m.

There is little doubt in the fact that a loan against a life insurance policy is a suitable secured loan. So if you have an emergency and are denied an unsecured loan, maybe this loan will help you overcome the same. To get a loan amount via this facility, individuals have just need to submit their policy as the collateral. Lower interest rates are one of the highlights of this loan facility.

The list of advantages of a loan against a life insurance policy is quite long and some of them are low-interest rates, higher loan amounts, minimal documentation, and quick loan disbursal. But apart from these, there are also a few shortcomings in this loan facility. In this article, we will tell you about all these lapses that you must keep an eye on while looking to get a loan against a life insurance policy. So, without any further delay, let’s get straight to them.

Disadvantages of Loan Against Life Insurance Policy

Opting for a Loan against life insurance policy can be a suitable borrowing option for you in difficult times. But there are some disadvantages too that you must remember and choose accordingly. All of them are mentioned below. Have a look!

Smaller Loan Amount in the Initial Policy Year

One of the common misconceptions among individuals is the loan amount in a loan against an insurance policy is decided on the total assured sum of the policy. We want to tell you that this is not true. The loan amount will be decided based on the overall surrender value of the policy. As a result, you may not get a higher loan amount if you apply during the initial policy years as it takes years to build a substantial surrender value of your policy.

The surrender value of your policy is the amount that a policyholder gets if he or she wants to discontinue the policy before maturity. This is also known as the Cash Value or Policyholder’s Equity. Lenders usually provide 85% to 90% of the Surrender Value as the loan amount. But if you decide to take a loan against your insurance policy in the initial years, you may not get a higher loan amount as the Surrender Value will not be that high.

The policies cannot be surrendered before the 3 years except some Unit-Linked Insurance Policies (ULIPs). Some of the ULIPs can be surrendered after one year but you will get the value only after three years due to the lock-in period. So, you must decide whether you want to get a smaller loan amount in the initial policy years or higher loan amount after accumulating considerable cash value. The choice is yours!

Type of Policy Against Which You can Get the Loan

One of the disadvantages of this loan facility is that you cannot get a loan amount by submitting any kind of insurance policy. The type of policy generally changes from one lender to another. Lenders generally give loan amounts against traditional plans, Money Endowment Plans, Money Back Plans, and also against Unit-Linked Insurance Policies (ULIPs). You can not get a loan amount against term plans as they don’t come with a surrender value.

So, it is important to check the policy you have before applying for a loan. It will not only help you enjoy hassle-free approvals but also prevent undue rejections that can happen by submitting wrong insurance policies.

Waiting Period on Policy

This is one thing that a lot of individuals don’t know about — The waiting Period on your policy. This waiting period is generally 3 years. Before this period, you cannot get any kind of loan amount against your life insurance policy. So if you are thinking of applying for a loan against your policy right after buying it, sorry to tell you that it’s not possible.

The reason behind this is that lenders check the amount of premium paid, the number of premiums paid during this period of three years, and whether you have missed paying any due premium. And according to this, your interest rates will be decided. If you have paid a higher premium amount and have done so for a greater number of times, the interest rates will most likely be on the lower side. So, this is one disadvantage of getting a loan against a life insurance policy that you cannot get a loan amount right after opting for a policy.

Policy Lapse in Case You Default in Repayment

You also need to remember that in case you default while repaying the interest on your loan amount, your policy may lapse. Also, you must know that even after getting the loan amount against your policy, you will need to continue the premium for your policy, otherwise, your policy will lapse. So, you need to pay both the loan dues and insurance premiums on time to ensure the policy does not lapse. If you keep missing your payments for a long time, the interest will accumulate, and it can go above the surrender value.

Also, in case of the death of the borrower, both the loan amount and interest amount will be paid by the sum assured of the policy and the remaining amount will be given to the nominee. So, you must look at this factor before applying for any loan against life insurance policy.