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Key takeaways:
Borrowing against your life insurance policy is an option exclusive to whole life insurance or universal life insurance policies.
Here’s how borrowing against life insurance works in Canada:
You should probably reconsider if the main reason you want whole or universal life insurance is to borrow against it. This type of policy isn’t the best fit for everyone, despite what TikTok financial influencers might say.
For starters, whole life insurance costs 5-15 times more than a term policy. On top of that, you’ll be paying those sky-high premiums for your entire life.
Make sure to do your research. Look up the best life insurance in Canada; our guide to the best whole life options is a good place to start:
You shouldn't borrow against your life insurance policy if your main reason for having coverage is protecting your loved ones.
Many people seek out whole or universal life insurance policies over term life insurance so that the option to borrow is available to them.
Financial experts have different takes on whether you should borrow against your life insurance policy. For Dave Ramsey, it’s a hard no:
When it comes to borrowing from your life insurance policy, do the advantages outweigh the disadvantages?
Pros:
Quick access to cash.
Doesn't affect your credit score.
Flexibility in when you pay it back.
Cons:
You have to wait for cash value to build up.
You can lose your coverage if you don't pay.
Your only options are whole or universal life insurance.
1. Quick access to cash
Borrowing money against your life insurance policy is a quick process.
You fill out a form with your insurer and the money is typically deposited into your account within a few days, making it a great option for those looking to access funds quickly.
And since your insurer is using your policy’s cash value as collateral, you don’t have to jump through hoops of approval.
2. Doesn’t affect your credit score
Borrowing against your life insurance policy also means no credit check, since the cash value is the insurer’s collateral.
This makes it an appealing option for those with low credit scores who may not be able to borrow money otherwise. It also means that this loan will not affect your credit.
3. Flexibility in when you pay it back
When it comes to borrowing money against your life insurance policy, there’s no set time limit for when you pay it back.
That said, you’ll still want to consider paying the loan back at your earliest convenience to avoid hefty interest charges.
1. You have to wait for cash value to build up
Since your life insurance policy’s cash value is the loan’s collateral, you have to wait for the cash value to build up enough for you to borrow against.
It can take a long time for this to happen, often upwards of 10 years, meaning the option to borrow won’t be available right away. To give you an idea, here's the average rate of return on a whole policy compared to other avenues:
2. You can lose your coverage if you don't pay
The interest on your loan will accumulate if you don't pay and may exceed your policy's cash value. Your insurer may then have to dig into your policy's death benefit to recoup their loss.
You may think you're just borrowing from yourself, but you also want to make sure you're not borrowing from your loved ones, too, when they need that financial safety net most.
3. Your only options are whole or universal life insurance
If you want to take advantage of this option, you need to have a whole or universal life insurance policy in place.
These types of life insurance policies cover you for your whole life. But universal and whole life insurance premiums are expensive and provide more coverage than most Canadians need.
This is especially true if your main reason for getting life insurance is to protect your financial dependents rather than passing down large assets.
For most Canadians, term life insurance is the way to go. Whole and universal life insurance may offer perks like borrowing against your policy later on, but it's not necessarily the best choice for your finances.
The premiums for term life insurance in Canada are significantly cheaper than whole, which means you can use the extra money at your discretion instead of worrying about repaying interest on your own money!
With a term policy, you invest or put the difference in a TFSA or RRSP account, giving you more control over your cash.
And your insurance needs will change as your family's situation does. Why tie up your funds in a policy that may not be worth it long-term?
With term life insurance, you're covered for the term length you need, like when your kids are young and financially dependent on you.
You can borrow against your life insurance policy as soon as your policy has built up enough cash value to do so. While the exact timeframe depends on your policy’s terms, it typically takes at least a decade to accumulate enough cash value.
The interest rate on a life insurance loan varies depending on the life insurance company you’re with, your policy’s terms, and whether your interest rate is fixed or variable.
That said, interest rates for borrowing against life insurance are typically between 5-8%.
It’s different for every insurer, but you can typically borrow an amount close to the total cash value, with most insurers allowing you to borrow up to 90%.
Yes, it is possible to take out a loan against your life insurance policy in Canada, but only if you have a permanent life insurance policy like whole life or universal life insurance.
Like your policy's death benefit, money borrowed from life insurance is not taxable as long as the policy is still in force. Your loan will become taxable, however, if you surrender your policy or your policy lapses and the amount owing on the loan exceeds what was paid into the policy.
Life insurance's cash value is related to the investment component of the policy — if applicable. Some life insurance policies don't offer cash value, so it'll depend on the kind of life insurance you have. In most cases, cash value is offered in permanent life insurance plans like whole life and universal life. But not all types of permanent life insurance coverage have it!
Infinite banking, or the idea of borrowing against your life insurance policy to become your own banker, can be intriguing—but it’s not a one-size-fits-all solution. In Canada, this strategy is mostly tied to whole life insurance policies, where you build up cash value over time. The appeal? You can take out loans against your policy, using it as collateral, while your money still grows. Sounds great, right? But here's the catch: these loans aren’t free. You’ll pay interest, and if you don’t manage them carefully, it could impact the policy’s benefits or even cause it to lapse.
So, is it a good idea? It depends on your financial goals and discipline. If you’re looking for a way to leverage your life insurance as a financial tool and you’re comfortable managing debt, it could work. But remember, it’s a long-term commitment. It’s essential to fully understand the risks and costs involved before diving in. Talking to a financial advisor who knows the Canadian market can help you make a smart decision.
Many insurance experts believe that it is too risky to take a loan from your life insurance because it has an impact on the coverage amount (death benefit/lump sum payout). If you pass away before you've paid the loan back, your loved ones won't get the full death benefit amount that you initially signed up for, causing potential financial strain on them.
To be fair, there are inherent risks with taking on any kind of debt, but borrowing against your life insurance may leave your family in a tough spot.
