insurance

Policy Loan

A loan you can take against the cash value that has accumulated in a permanent life insurance policy, such as whole life or universal life. The policy itself serves as collateral, and you're essentially borrowing your own money that the policy has built up over time.

Example

“After 15 years of paying premiums, Sarah took a $10,000 policy loan against her whole life insurance to help pay for her daughter's college tuition.”

Memory Tip

Remember 'Policy Loan = Piggy Bank Loan' - you're borrowing from the savings account inside your life insurance policy.

Why It Matters

Policy loans provide access to cash without having to qualify for traditional bank loans, and the interest you pay goes back into your policy rather than to a bank. However, unpaid loans reduce the death benefit and can cause the policy to lapse if they exceed the cash value.

Common Misconception

Many people think policy loans are free money since it's their own cash value, but these loans typically charge interest rates of 5-8% annually. Others believe taking a loan doesn't affect their life insurance coverage, when actually unpaid loans directly reduce the death benefit paid to beneficiaries.

In Practice

If your whole life policy has $25,000 in cash value and a $100,000 death benefit, you could borrow up to about $22,500 (policies typically allow loans up to 90% of cash value). If you borrow $15,000 at 6% interest and don't repay it, after one year you'd owe $15,900, and your death benefit would be reduced from $100,000 to $84,100. The loan continues to compound annually until repaid or until it potentially causes the policy to lapse.

Etymology

Combines 'policy' from French 'police' meaning contract with 'loan' from Old Norse 'lán,' emerging in the early 1900s as permanent life insurance policies began building cash value.

Common Misspellings

polacy loanpolicy lonepolisy loanpolocy loan

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