Loan Against Life Insurance Policy: A Complete Guide

When a person faces a financial crisis or requires urgent funds, then the first thing that comes to their mind is to take a loan. Nowadays, many loans are readily available in the market. These various types of available loans only need clarification on a person.One of the best ways to take a loan is through a life Insurance policy . The interest rate is comparatively less. This asset (the life insurance policy) is kept as collateral or security against the loan amount. This way, the life insurance policy is intact, and the cash crunch problem is solved. Some lenders also provide loans against ULIPs (Unit-Linked Insurance Plans). These ULIPs are used not only as insurance policies but also as investment plans.

1. The interest rate applied on a loan against a life insurance policy depends on the applicant's profile.
2. The interest rate for a loan against a life insurance policy is relatively low. Any loan taken from a bank has an interest rate of 12 to 14%. While the interest rate of personal loans availed through a life insurance policy is 10.5% to 12.5%.
3. To avail of the loan, the life insurance policy has to be surrendered to the bank, the lender or an insurance company. The loan amount is given as an advance on the policy's surrender value.
4. This loan is given only to the person having a life insurance policy. It is not given to a person holding any other term insurance plans.
5. The interest rate for a loan against a life insurance policy is relatively low. The interest rate of personal loans taken from banks is between 12 to 14%. While the interest rate of personal loans availed through a life insurance policy is 10.5% to 12.5%.
6. The loan amount depends on the surrender value of the life insurance policy. Usually, the loan amount is 90% of the policy value.
7. Defaulters will not get the maturity amount since this policy is held as collateral and will be terminated. It happens when the loan debt exceeds the policy's surrender value.
8. If the policy matures before the completion of the loan, then the insurance company deducts the difference amount from the maturity amount and the loan that is still pending. After these deductions, the maturity amount is handed to the policyholder.
9. A loan taken against a life insurance policy is helpful for those with a low credit score (it reflects the creditworthiness of a person). However, having a good credit score will be an added advantage. It can help in reducing the rate of interest charged on this loan.
10. Since the applicant already has a life insurance policy which will be kept as collateral, there is no further need for any additional documentation to prove if the person is eligible for the loan or not. Essential documents for KYC(Know Your Customer), like identity cards, residence proof, etc., are sufficient. Mobile numbers and email IDs are also required to provide updates for the loan application.
11. However, the original life insurance policy has to be submitted to the lender along with a letter agreeing to the terms and conditions of the lender, bank or insurance company.

Also Read : 7 Factors That Determine Your Life Insurance Policy Premiums

There are no strict norms as to who is eligible for a loan against the life insurance policy compared to other term insurance loans. It is often pre-approved, so there aren’t any eligibility criteria for these pre-approved loans.The eligibility criteria to avail of a loan against the life insurance policy, if it is not pre-approved, are as follows:

1. The applicant for this loan should not be less than 21 years of age.
2. The applicant should be an Indian citizen.
3. The applicant can either be a salaried person or a self-employed person.
4. The person must have a life insurance policy in their name.
5. This policyholder, who is also an applicant for a loan, must have a regular source of income.
6. Some banks are particular about the minimum amount of insurance policy that has to be taken by the applicant. Most lenders and insurance companies do not have any issue with the minimum amount of the life insurance policy.

Some of the benefits of taking a loan against the life insurance policy are stated below:

1. The interest rate for a loan against a life insurance policy is relatively low. The interest rate of personal loans taken from banks is between 12 to 14%. While the interest rate of personal loans availed through a life insurance policy is 10.5% to 12.5%.
2. A loan taken against a life insurance policy is a hassle-free process. It requires minimal documentation and is usually approved instantly. The chances of the loan getting rejected are next to none.
3. A loan against a life insurance policy is helpful for those with a low credit score. The credit score is usually checked for people who apply for a loan, which reflects a person's creditworthiness.
4. Since the applicant already has a life insurance policy that will be kept as collateral, there is no further need for any documentation to prove whether the person is eligible for the loan.
5. In case of the policyholder's demise during the loan tenure, the policy amount is given to the nominee after deducting the loan amount.

Some of the documents that are supposed to be submitted while applying for this loan are:

1. A loan application form : All the relevant information must be provided here. This information is personal and residential details. The applicant should also submit bank details and contact details.
2. The original life insurance policy document has to be submitted. The original life insurance policy is kept as collateral by the lender.
3. A signed agreement states that the policyholder assigns the life insurance policy to the lender against a loan. It can be kept as collateral for the loan disbursed by the lender or the bank.

The interest rate is crucial to consider when taking any loan. A person applying for a loan compares the interest offered by banks and other lenders. The lender or the bank is finalised based on the one who offers a lesser interest rate. However, the interest rate is fixed when a loan is taken against a life insurance policy. The interest rate depends upon the premium paid annually and how many premiums the policyholder has paid so far. It also depends on the maturity value of the life insurance policy . If the premium paid is of more excellent value and the tenure is extended, then the interest rate will be low.In most circumstances, a loan's interest rate against a life insurance policy usually ranges between 10 to 12%per annum. The interest rate for a loan against a life insurance policy differs for everyone. It is determined by the lender, the bank or the insurance company from whom the loan is availed. Although the credit score doesn't play a significant role in availing a loan against a life insurance policy, a good credit score may be crucial in determining the interest rate applicable.A lower interest rate helps repay the loan faster and doesn’t even pinch the pocket. The EMI (Equated Monthly Installment) will also be less. Another thing to remember before applying for this loan is that the loan against a life insurance policy can be availed only after 3 years of the premium paid.

The loan amount is not on the overall value of the insurance policy. It is given on the surrender value of the life insurance policy. The surrender value is the amount receivable by the life insurance policyholder upon surrendering the insurance policy to the lender, bank or insurance company before its maturity.The lenders, insurance companies or banks usually give 80 to 90% of the surrender value of the life insurance policy as a loan amount. This loan amount may vary from one lender to the other. For example, a person has an insurance policy worth Rs. 40 lakhs. When the loan was applied, its surrender value was Rs. 20 lakhs. Based on the above example, the actual loan amount that can be sanctioned is Rs. 16 lakhs to Rs 18 lakhs.

Applying for a loan against the life insurance policy is relatively easy. The policyholder can either apply online or visit one of the branches of a bank, the lender's office or the life insurance office.

For the direct method:

visit the lender's office or bank and meet the representative. This representative will help the individual understand the loan procedure. Here the applicant needs to submit a duly filled and signed application form. The original life insurance policy has to be submitted along with the KYC ( Know Your Customer) documents. A canceled cheque from the bank will be required for bank account details. It is also needed for the loan amount to be deposited in the applicant's bank account after approval. Besides this, the applicant's mobile number and email ID must also be submitted. Once everything is verified and the loan amount is approved, it will be sent directly to the applicant's bank account.

For online loan application:

Visit the website of the lender or the bank. Fill in the loan application form and submit the required documents such as ID proof, residential proof, insurance policy document and passport-size photo. Bank details and contact details are also needed. Once the loan amount is sanctioned, it will be directly sent to the bank account. The original copy of the insurance policy has to be given to the lender. It can be done by personally visiting their office or having their representative take it from the residence.

The loan terms against a life insurance policy are the same as the policy term. The policyholder has to repay the dues before the maturity of the policy. However, the loan repayment terms against a life insurance policy vary from lender to lender. Most lenders allow the policyholder to pre-close the loan amount without taking any pre-closure charges. The policyholder must continue to pay the policy's premium so that it does not lapse. The loan amount should be cleared once the policyholder has cash flow. It will lessen the additional financial burden of clearing the loan dues.

Some of the drawbacks of taking a loan against a life insurance policy are:

1. Type of policy: Loans cannot be availed on all insurance policies. Some policies that allow the policyholder to avail of loans are Traditional Life Insurance Plans, Money Back Plans, Unit-Linked Insurance Policies, Unit-Linked Insurance Plans, and Money Endowment Plans. So the policyholder should check the type of life insurance policy they hold before applying for the loan. This will ensure a hassle-free process of the loan.
2. Smaller loan amount in the initial years: People think that a loan is disbursed against a life insurance policy on the sum assured of the policy. The loan is provided on the surrender value of the life insurance policy. As a result, the loan amount available will be relatively less because several years are needed to build the surrender value of the life insurance policy. If the requirement is for a higher loan, the policyholder must wait for at least 10 to 15 years.
3. The waiting period: Availability of a loan against a life insurance policy is 3 years. This means that a loan cannot be availed till 3 years of premium have been paid. Only ULIPs can be surrendered after 1 year, but the value will be given only after 3 years due to the lock-in period. The lenders check if the premiums were paid on time, and if any premium is missed, the interest rate is decided based on these verifications. These verifications won’t be possible at the inception of the life insurance policy. That is why a lock-in period has to be in force. Thus loan is not available immediately after taking a life insurance policy.
4. Default in repayment will result in policy lapse: The life insurance policy will lapse if the premium is not paid on time. Many insurance companies provide a grace period if the premium is unpaid until the stipulated due date. Policyholders must continue to pay the premium despite taking a loan. It will ensure the life insurance policy coverage is intact and active.

Life insurance provides security to a policyholder and the family too. Although it seems easy to avoid a financial crunch, one should not blindly jump into taking a loan. The premium should be paid on time to reap its benefits. However, in case of a cash crunch, when a person needs money, taking a loan on a life insurance policy might be a good option. It is because the interest rate is lower compared to other loans. Even if a loan is availed, the premium payment shouldn’t stop, as the insured person's insurance cover is intact. In case of an unfortunate incident, the nominee will receive the maturity amount.