How to avail loan against your insurance policy?

Loan against an insurance policy is a good option when funds are required in an emergency situation while being aware of its process.

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 a premium for quite a few endowment plans, I suggested he explore taking a loan against insurance policy. His eyes lit up and he wanted to know more about it. Here’s what I told him.

Related: What is loan against property?

How to obtain a loan on insurance policy

To get a loan against insurance policy, you’ll have to visit the branch of your insurance company and fill the standardized application form for a loan.

In the form, you’ll be asked to assign the policy absolutely in favour of the insurer which is usually 85% to 90%. 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 on insurance policy available for all types of loans?

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 a 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%).

Related: Taking a loan against your credit card? Here are some things you must know 

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. 

This raises the question, can you have more than one insurance policy? The answer is yes, you can. It means you can generate loan against insurance policy on various policies you hold as well.

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 inquire about the same before taking a loan.

For example, the maximum loan against insurance policy available from Aegon Religare is 60% of the Surrender Value of the policy. The 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 and interest thereon if any. In the event of the death of the Life Assured during the period of loan repayment, the outstanding loan and 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 the loan, the insurer will charge interest only up to the date of maturity/death. It is important to note that the loan should be repaid before the maturity of insurance policy. 

What does insurance policy maturity mean?

Insurance policy maturity means that before the age of 65, 85 or till whatever age your insurer continues to cover you, the policy holder should ideally repay the entire loan and the interest rate. If he pays only the interest rate, the principal amount will be deducted by the loan provider during the time of settlement. In a scenario where the policy holder passes away during the term of the loan, the pending amount will be deducted from the claim amount by the lender. The balance claim amount will go to the nominee.

Related: Are you smarter than your insurance agent?

Loan on 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 insurance policy 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? Read this article for tips on how you can apply SWOT analysis to your financial plan.