Know The Risks And Benefits: Loan Against Insurance Policies

According to the latest report from Life Insurance Council, the private life insurance industry in India has undergone a 35% growth in premiums in March 2023. Moreover, the total growth in premiums for the financial year 2022- 2023 increased by 20%. 

The benefit of an insurance policy is not limited to providing financial protection to the beneficiaries of the policyholder. People can use their insurance policies as collateral to apply for loans from financial institutions. In the following sections, benefits, risks, and other crucial details of loans against insurance policies are discussed. 

What is a Loan Against Insurance Policy? 

A life insurance policy is a contract between an individual and an insurance company. The policyholder is required to make periodic payments of premiums. In return, the insurer promises to pay a certain amount to the beneficiaries in the event of the policyholder’s death. Some life insurance policies offer an amount called maturity benefit to a policyholder after the policy term.

A loan against insurance policy is an attractive alternative compared to a personal loan or liquidating assets. But, potential borrowers must check whether their insurance plan is listed under eligible collateral by a financial institution. 

Benefits of Loan Against Insurance Policy 

Here are the benefits of loans against insurance policies: 

• Lower interest rates: Considering that this is a secured loan, the interest rates are typically lower than for personal loans.

• Few chances of rejection: There are fewer chances of rejection because borrowers pledge life insurance policies with the insurer.

• Hassle-free procedure: Nowadays, applying for a loan against an insurance policy has become much easier as people can submit online applications. 

• Quick disbursement: Not many documents are required and because of minimum documentation, the application processing time and loan disbursement time are much quicker. 

• Less scrutiny: As it is a secured loan, there’s much less scrutiny of the application form. This is beneficial to people with low credit scores.

• Loans against insurance with lock-in periods: Certain financial institutions sanction loans even if the insurance policy is under a lock-in period. This makes this loan suitable for anyone looking for funds to deal with an emergency.

Risks of Loan Against Insurance Policy 

A loan against an insurance policy indeed has many benefits but borrowers need to be aware of the risks as well: 

• Failure to repay adds interest to the balance amount

What happens if a borrower fails to repay the loan taken against an insurance policy? In such a situation, the interest will get added to the balance amount. If the loan amount exceeds the insurance plan’s cash value, the policy may lapse.

Before terminating the insurance policy, the insurance company will recover the outstanding dues from the policy’s surrender value.

Suppose Arun has availed a loan of Rs.3.5 lakh against an insurance policy of Rs.5 lakh and has failed to repay it. If his total loan amount exceeds the surrender value, Arun’s insurance policy will lapse. But, if his loan amount doesn’t exceed the surrender value, Arun’s insurer will recover his outstanding dues from the policy’s surrender value and pay out the rest.

• Beneficiaries will not receive the full benefits 

When a policyholder dies, his/her beneficiaries will not be able to receive the entire policy benefits. The insurance company will deduct the outstanding loan and interest and then pay the death benefits to any beneficiary. 

Eligibility Criteria for Loan Against Insurance Policy

Borrowers must remember that different banks/NBFCs have different eligibility criteria for this financing option. Usually, applicants must fulfill the following criteria: 

• Applicant must be an Indian citizen, either salaried or self-employed, and aged between 18 to 65 years.

• The minimum surrender value of a policy must be Rs.30,000.

• The insurance policy must be listed under a lender’s approved policies.

Documents required 

Applicants must keep these documents ready. It is important to note that lenders may require additional documents for verification.

• Aadhaar card/passport/voter’s ID card 

• PAN card 

• Insurance policy documents 

• Copy of cheque of bank account/bank account statements

Important Factors to Consider While Taking a Loan Against Insurance Policy

Here are a few important factors to check before applying for this loan: 

• Eligibility 

Applicants must consider whether the insurance policy is eligible for collateral or not. Generally, people can avail of a loan against life insurance policies that offer maturity benefits and unit-linked insurance plans (ULIPs) and not against term insurance policies.

• Rate of interest 

Generally, borrowers must pay interest only on the utilised loan amount. But it is advisable to know the details regarding loan against life insurance policy interest rate as they tend to vary from one lender to another. Usually, the interest levied on these loans depends on the interest rates applicable when the policyholder purchased the insurance plan. 

• Loan amount

Borrowers must check the maximum loan they can avail from their preferred lender. If it is not aligned with their financial requirement, they should search for different lenders. There are lending institutions that offer loans of up to Rs.25 crores against insurance policies.

• Repayment 

Borrowers need to remember that the repayment terms for loans against insurance policies vary from one lender to another. But, usually, the tenure is flexible. 

To sum up, a loan against an insurance policy comes with many benefits such as lower interest rates and hassle-free procedures. Applicants, especially those with low credit scores, can consider this financing option when faced with financial emergencies. 

Also check – 10 Factors to Consider Before Prepaying Your Home Loan