Understanding Cash Value Loans: How They Work and When to Consider Them

When you own a life insurance policy with a cash value component, a cash value loan can feel like a practical way to access funds without answering to a bank. But what exactly is a cash value loan, and what should you consider before borrowing against your policy? This guide explains the mechanics, costs, and real-world trade-offs, so you can decide if a cash value loan is the right move for your situation.

What is a cash value loan?

A cash value loan is a loan taken against the accumulated cash value inside a permanent life insurance policy—such as whole life or universal life. Unlike a traditional loan from a bank, you’re borrowing from your own policy’s cash value rather than from an external lender. The loan is secured by the policy itself, and you don’t need to prove income or have strong credit to qualify.

Key points to know about a cash value loan are:

The loan is typically not taxed at the time you borrow, as long as the policy remains in force and you don’t lapse the coverage.
The outstanding loan balance reduces the death benefit your beneficiaries would receive if you pass away.
The cash value can continue to earn interest or dividends as long as the policy remains active, but those earnings may be reduced by the loan and interest charged.

How a cash value loan works

When you take out a cash value loan, you are borrowing a portion of the policy’s accumulated cash value. The insurer may allow borrowing up to a portion of the available cash value, depending on the policy type and terms. There are two common modes of interaction:

Interest accrues on the loan: The loan balance typically accrues interest over time. If you repay the loan, you reduce the balance and the amount of interest you owe.
Impact on cash value and death benefit: The loan balance reduces both the policy’s cash value and the death benefit by the amount borrowed, plus any unpaid interest. If the loan grows too large, it can threaten the policy’s ability to remain in force.

Many policies require no ongoing repayment, which can be convenient in the short term. However, interest continues to accumulate, and unpaid interest can compound. If the outstanding loan plus interest ever exceeds the policy’s cash value, the policy could lapse, potentially triggering tax consequences and a loss of coverage.

When to consider a cash value loan

A cash value loan can be attractive in certain situations where quick liquidity is needed and other options are less favorable. Common use cases include:

Covering unexpected medical expenses or urgent home repairs
Paying for major purchases without high-interest debt
Funding education costs or a business opportunity when traditional loans are hard to obtain
A temporary bridge if you’re between jobs or facing cash flow gaps

However, because a cash value loan reduces the death benefit and can affect policy performance, it is usually wise to consider it only after evaluating other options, such as emergency savings, a personal loan, or a home equity loan.

Pros and cons of a cash value loan

Understanding the trade-offs can help you determine whether a cash value loan aligns with your financial goals. Here are common pros and cons:

Pros

No credit check or income verification is typically required
Funds are often available quickly, with flexible repayment options
No ongoing premium changes are required to access the loan, unless you choose to adjust policy features

Cons

Borrowed funds reduce the death benefit your beneficiaries receive
Interest accrues on the loan and can compound if not repaid
If the loan balance grows too large, the policy could lapse, triggering taxes and losing coverage
Longer-term reliance on a cash value loan may undermine the policy’s growth potential

Costs, interest rates, and terms

Interest rates on cash value loans vary by insurer and policy type. Some policies charge a fixed rate, while others use a variable rate tied to a benchmark plus a margin. In general, a cash value loan’s interest rate tends to be competitive with other unsecured loan options, but it can be higher or lower depending on the policy structure and market conditions.

Important considerations include:

Whether the loan has a minimum or maximum repayment term
Whether loan interest is charged monthly, annually, or periodically
How the loan interacts with policy charges and any rider benefits

Always review the policy illustration or speak with a licensed agent to understand the specific costs and how they affect both the cash value and the death benefit over time.

Tax implications and effects on the death benefit

In many cases, a cash value loan is not taxed as income because you’re borrowing against your own money. However, there are important caveats:

If the policy remains in force and you repay the loan, there are typically no tax consequences.
If the policy lapses or is surrendered with an outstanding loan, the loan amount may be considered taxable income, and you could owe taxes on the growth portion of the cash value that exceeds the premiums paid into the policy.
Any outstanding loan balance at the time of death will generally reduce the death benefit paid to beneficiaries, potentially altering estate planning goals.

Tax treatment can depend on policy type, ownership, and changes in tax law. Consulting with a tax advisor or financial planner who understands life insurance products is advisable if you’re considering a cash value loan as part of your strategy.

How to apply for a cash value loan

Borrowing against your policy is typically straightforward, but it helps to prepare. Steps often include:

Review your policy documents to confirm you have a cash value and understand any withdrawal or loan provisions
Contact your insurer or the agent who sold you the policy to initiate the loan request
Decide how much you want to borrow, keeping in mind the potential impact on the death benefit and policy stability
Choose a repayment plan, or confirm that the loan can remain outstanding without a fixed repayment schedule
Monitor the loan balance and interest to avoid unexpected policy lapse or tax consequences

Some policies also offer automated repayment options or the ability to set a target loan-to-value ratio. Take time to compare offers from the insurer and consider how a cash value loan fits with your broader financial plan.

Alternatives to a cash value loan

Before borrowing from your policy, consider other options that may preserve the policy’s integrity and death benefit:

Emergency savings or a high-yield savings account for liquidity
Personal loan or line of credit with a clear repayment plan
Credit card balance management or a balance transfer to lower-interest debt
Policy withdrawal (partial surrender) if you don’t need the policy to remain in force
Revisiting the policy’s riders or converting it into a product with different features

Each option has its own costs and benefits. A cash value loan can be a convenient bridge, but it is not a free source of funds, and it carries the risk of reducing future life insurance protection.

Common questions about cash value loans

To wrap up, here are answers to a few frequent questions people have about cash value loans:

Is a cash value loan the same as a withdrawal? No. A withdrawal reduces the cash value and may be subject to surrender charges or taxes, while a loan leaves the cash value intact and borrows against it, though it still reduces the death benefit and can accrue interest.
Will I lose coverage if I don’t repay? Not automatically. However, if the loan plus accrued interest exceeds the cash value and causes the policy to lapse, coverage ends and taxes could apply.
Can I borrow from any life insurance policy? Not all policies allow cash value loans. Typically, permanent life insurance policies with a cash value component offer this option.

Bottom line

A cash value loan can be a valuable source of liquidity for policyholders who need quick access to funds without the hurdles of a bank loan. The key is to understand how the loan interacts with the policy’s cash value and death benefit, weigh the costs and risks, and plan repayment thoughtfully. If you’re considering a cash value loan, consult your insurer, review your policy illustration, and discuss your options with a financial advisor to ensure that you remain on track with your long-term goals and protection needs.