Borrowing Against Your Policy
One of the most powerful features of whole life insurance is the ability to leverage your policy. You act as your own bank, accessing capital without asking for permission.
The Mechanics of a Policy Loan
When you "borrow" from your life insurance, you are not actually withdrawing your own money. Instead, the insurance company lends you their money and uses your Cash Value as collateral.
🔒 Compound Growth Continues
Because your money technically stays in the policy (as collateral), it continues to earn dividends and interest on the full balance, even while you have a loan outstanding.
🚫 No Credit Checks
The loan is secured by your cash value. The insurer does not care about your credit score, income, or employment status.
📅 Flexible Repayment
You set the terms. You can pay it back monthly, annually, or never. However, unpaid interest will add to the loan balance.
The Arbitrage Opportunity
Sophisticated investors use whole life for "arbitrage." This happens when the Dividend Rate you earn is higher than the loan interest rate you pay.
- Direct Recognition: The company lowers the dividend rate on the specific money you have borrowed.
- Non-Direct Recognition: The company pays you the SAME dividend rate regardless of loans. This is where arbitrage is possible. If the loan costs 5 percent but the policy earns 6 percent, you are making a 1 percent "spread" on borrowed money.
Policy Loan vs. Bank Loan
| Feature | Policy Loan | Bank Loan |
|---|---|---|
| Approval Process | Instant / Guaranteed | Credit Check / Application |
| Repayment Terms | Voluntary | Strict Schedule |
| Impact on Credit | None | Recorded on Report |
⚠️ The "Tax Time Bomb"
Policy loans are generally tax-free. HOWEVER, if you borrow too much (e.g., 90 percent of your cash value) and the interest compounds, your loan balance might exceed your cash value. If this happens, the policy will lapse (cancel itself).
If the policy lapses with a loan outstanding, the IRS treats the loan as income. You could owe a massive tax bill on money you already spent years ago.