What would you do if you are in the middle of a financial crisis? Would you opt for a bank loan or a loan against your life insurance policy? Is it more beneficial if we opt for a loan against life insurance plan?
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Let’s take a look at the advantages and the disadvantages of loan against your life insurance plan before deciding:
The amount of loan you can avail against your life insurance plan depends on its surrender value. Thus you cannot get a loan against your term life plan, however, endowment plan or traditional money back plans offers you such facility. Usually, insurers allow policyholders to get a loan amounting to 80-90% of the surrender value of the policy.
For example, if you have an insurance cover of Rs. 50 lakh on your endowment plan and its surrender value is Rs. 20 Lakh then you are eligible to get a maximum loan amount of Rs. 17 to 18 lakhs.
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The interest rate for such loans is lower than conventional unsecured loans. Thus the insurance companies offer these loans at a lower interest rate if the insurance premium is already paid for a certain number of years. The more the premium amount and the lower will be the interest rate on the loan availed.
Loan against insurance score over conventional loans due to factors like fast approval and minimal paperwork. The application process of such loans is easier than bank loans and they require less time to process. A borrower can access loans quickly within a matter of a few days as the policyholder is already a verified person. Typically, policyholders get funds within 3 to 5 days of applying for a loan.
Since you pledge the insurance plans as collateral against your loan, your insurer remains secured in case of a default. Thus you get a loan at a lower interest rate. As you have already pledged the policy by assigning it to your lender, your loan will be considered a secured loan. There will be less scrutiny and the loan will be sanctioned within 3 to 4 days.
It is unwise if you think that loan against such policies are only based on the surrender value of your policy. Before you avail a loan, you need to accumulate some value on your policy. Even if your policy contains the term pre-approved loan, you can only avail funds if your policy has gained a surrender value. For this, you have to pay regular premiums for at least 3 years from the date of purchase of the policy.
Not all life insurance plans come with a loan facility. You cannot avail a loan against a term insurance policy as they do not have any cash value at maturity. Similarly, most of the ULIP plans also do not come with loan options. The loans facility is offered on traditional plans like money-back policies, endowment plans, and whole life plans that have a surrender value attached to it. Since these policies are also used to accumulate a corpus in the long run, they come with a loan feature.
A Policyholder cannot apply for a loan before the waiting period. Life insurance policies that come with loan facilities have a waiting period of about three years during which you have to make timely and regular premium payments. The loan is sanctioned to individuals who pay their premiums responsibly without delay.
While deciding to buy a policy you must never think of the loan feature first. An insurance plan is usually purchased to avail insurance cover and to provide financial security to your dependents. However, you may avail a loan against your policy only in a grave financial crisis. If you are unable to arrange funds from bank loans or from family and friends then this can be a great alternative for you.
But remember to repay your loan as soon as possible because once you take a loan against your policy, it gets assigned to your lender and you are left with no insurance cover. The lender in such cases acquires the right to deduct the loan amount and interest outstanding in case of the sudden demise of the borrower.
Also, you have to keep paying insurance premiums along with your loan EMIs to keep your policy into force. In case of default in repayment of loan or default in repayment of premiums, the policy will lapse. Thus you need to be careful before availing such loans. Consider such a loan only if you have a good income or if your debt to income ratio is low.
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