My friend Vinay seemed worried when I met him at his place on a Sunday afternoon. When I asked why, he shared with me that due to the market downturn, he had been laid off from his job. Moreover, given the gloomy economic environment, he said it would take him a couple of months to find a decent new job. That was when he acknowledged his mistake of not having maintained a dedicated emergency fund and contemplated taking a personal loan to tide over the period.
Since I knew that he was already paying premium for quite a few endowment plans, I suggested he explore taking a loan on his insurance policies. His eyes lit up and he wanted to know more about it. Here’s what I told him.
How to obtain a loan against policy
You’ll have to visit the branch of your preferred insurance company and fill the standardised application form for a loan.
In the form, you’ll be asked to assign the policy absolutely in favour of the insurer. This essentially means that in case of a claim/maturity benefit due, the insurer will have the first right over the money and will repay you after deducting the outstanding loan principal and interest. Since nowadays insurers have stopped issuing cheques, you’ll have to also provide a cancelled cheque of the bank account in which you want the loan amount to be credited by the insurer and sign a receipt for the same.
Is a loan available for all insurance policies?
As per IRDA’s guidelines on Linked Insurance products, Unit Linked Insurance Plans can no longer offer a policy loan. So, as on date, this feature is generally available only for traditional non-linked endowment based policies wherein after you pay premium for a certain number of years (usually three), the policy acquires a surrender value. The loan amount is a percentage of that surrender value (usually around 60- 80%).
Hence, if you are contemplating a loan against insurance policy, you need to first check whether your policy is eligible for a loan or not. For this, you can read the fine print but the better option is to visit the branch to know the surrender value of the policy and how much loan can be obtained against it.
Apart from getting a loan, this feature can also enable the policy to serve as collateral for some other loan. E.g. imagine a situation wherein you are purchasing a flat and need a fixed amount for the down-payment but are falling short by a couple of lacs. In such a case, you can assign the policy to the bank or Non-Banking Financial Company (NBFC) providing the home loan.
Rate of interest and other terms and conditions
The rate of interest and other terms of the loan will vary from insurer to insurer, so it is important to enquire about the same before taking a loan.
For example, the maximum loan amount available under the policy in case of Aegon Religare is 60% of the Surrender Value of the policy. Rate of interest charged on loans varies depending on market dynamics and is generally linked to G-Sec rates.
All benefits given under the Aegon Religare policy would thus be adjusted against the outstanding loan & interest thereon, if any. In the event of death of the Life Assured during the period of loan repayment, the outstanding loan & interest thereon shall be adjusted from the benefits payable. Similarly, in the event the policy is surrendered or matures for payment, the outstanding loan amount with interest outstanding thereon will be adjusted by the company from the surrender value or maturity value payable, as the case may be.
Though Aegon Religare does not have a minimum period for which a loan can be granted, some insurers may. In that case, even if the loan is repaid within the stated minimum period, interest for the entire minimum period will have to be paid. However, in case the policy becomes a claim either by maturity or death within such a minimum period from the date of loan, the insurer will charge interest only up to the date of maturity/death.
Loan against insurance policy should be the last option
Though this feature is available for some policies, a policyholder should not be dependent on it. As a good fiscal measure, you should have minimum six to twelve months of your fixed monthly commitments like household expenses, loan EMIs etc. in a fixed deposit or a liquid mutual fund scheme and this should be a dedicated emergency fund that can be used in case of an emergency.
Availing a loan against your insurance policies is a good low cost option in case funds are required in an emergency situation and a better alternative to a personal loan or a credit card loan or even asking your friends/relatives for financial help. However, these loans should be explored only as a last resort when all other options/ fund sources have dried up.
What did Vinay decide to do?
After our discussion, Vinay felt relieved and finally decided to go for it, albeit with a promise to maintain a dedicated emergency fund in the future to see off such difficult times.
Have you found yourself in a sticky financial situation recently? Leave your questions below and we’ll get back to you.
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