Life insurance helps to safeguard individuals and their family against financial risks because of untimely death. Life insurance policies can also be pledged to avail loans during any financial emergency. Individuals can pledge only their traditional plans, like endowment or money-back plans. Term plans are not eligible and even for unit-linked insurance plans (Ulips), some insurers do provide loans, while others deny giving any loans.

Once an individual has decided to take a loan against the policy, there are a few other parameters that need to be fulfilled. Investors will get the loan amount only after they have paid the premiums for at least three consecutive years. So if the policy has been in existence for less than three years, the policyholder might not get the loan.

Loan amount and interest charged

For the loan amount, one needs to check it with the insurance company, as it varies from insurer to insurer. In general, insurers provide loans of up to 80–90% of the surrender value of the policy. If an investor has a Rs 10 lakh policy and the surrender value is Rs 3 lakh, then he will get a loan of Rs 2.4–2.7 lakh. Even the interest rates vary from one company to another. Typically, it is between 9% and 12%. One of the major attractions of loans against insurance is the lower interest rates compared to taking a personal loan, where interest rates can go above 16–18%.

Even the documentation is very simple, as the individual needs to fill out the form from the insurance company and submit the original insurance copy to the insurer.

Premium payment and repayment of loans

Once the investor gets the loan, he needs to continue to pay the premiums on the policy against which he has taken the loan. Like every other loan here too, investors need to repay their loan during the term of the policy. Here, the policyholders have the option to pay interest along with the principal amount or only the interest amount. In a case where only interest has been paid, the principal amount will be deducted from the claim amount at the time of settlement.

If, for any reason, the policyholder dies during the period and he has only paid the interest, the pending loan amount will be deducted from the settlement amount, and the other part will be paid to the nominee. If the investor fails to pay even the interest and loan value exceeds the cash value, then the policy will lapse, and insurers can recover the loan amount from the surrender value of the policy.

Before taking the loan, one needs to check the interest rates and term payment period with the insurer. This loan is only meant to be taken to meet very short to medium-term financial crunches and not for long-term needs. The focus should remain on paying back the loan amount as soon as possible so that insurance coverage remains intact.

The writer is director, Probus Insurance Broker