Borrowing Against Life Insurance Canada: Money Hack or Risky Move?

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Erik Heidebrecht
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Certified Life Insurance Advisor

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In This Article

Key takeaways:

  • You can borrow against life insurance in Canada if you have a whole or universal life insurance policy.
  • While TikTok financial influencers may tell you whole or universal policies are the ticket to paying off debts, the truth is not that simple.
  • The loan is taken using your policy’s cash value as collateral.
  • It can take upwards of 10 years to build up enough cash value to borrow from. And interest on your loan means your policy's payout could be reduced.

How does borrowing money against life insurance work?

Borrowing against your life insurance policy is an option exclusive to whole life insurance or universal life insurance policies. 

Here’s how borrowing against life insurance works in Canada:

  1. As you pay your premiums, part of your payments go toward building a cash value for your policy. 
  2. This cash value grows at an interest rate determined by your policy’s terms. Once you’ve accumulated enough cash value, you then have the option to borrow against it. 
  3. This loan is not taken from your death benefit or cash value.
  4. Instead, you borrow from the insurer directly, who uses the value your policy has built up as collateral. 

You should probably reconsider if the main reason you want whole or universal life insurance is to borrow against it. This type of policy isn’t the best fit for everyone, despite what TikTok financial influencers might say.

For starters, whole life insurance costs 5-15 times more than a term policy. On top of that, you’ll be paying those sky-high premiums for your entire life.

Make sure to do your research. Look up the best life insurance in Canada; our guide to the best whole life options is a good place to start:

Should you borrow against your life insurance policy?

You shouldn't borrow against your life insurance policy if your main reason for having coverage is protecting your loved ones.

Many people seek out whole or universal life insurance policies over term life insurance so that the option to borrow is available to them. 

Financial experts have different takes on whether you should borrow against your life insurance policy. For Dave Ramsey, it’s a hard no:

Borrowing against your life insurance policy: pros & cons

When it comes to borrowing from your life insurance policy, do the advantages outweigh the disadvantages?

Quick summary: pros & cons of borrowing against life insurance

Pros:

Quick access to cash.

Doesn't affect your credit score.

Flexibility in when you pay it back.

Cons:

You have to wait for cash value to build up.

You can lose your coverage if you don't pay.

Your only options are whole or universal life insurance.

Advantages of borrowing against your life insurance policy

1. Quick access to cash

Borrowing money against your life insurance policy is a quick process. 

You fill out a form with your insurer and the money is typically deposited into your account within a few days, making it a great option for those looking to access funds quickly. 

And since your insurer is using your policy’s cash value as collateral, you don’t have to jump through hoops of approval.

2. Doesn’t affect your credit score

Borrowing against your life insurance policy also means no credit check, since the cash value is the insurer’s collateral. 

This makes it an appealing option for those with low credit scores who may not be able to borrow money otherwise. It also means that this loan will not affect your credit.

3. Flexibility in when you pay it back 

When it comes to borrowing money against your life insurance policy, there’s no set time limit for when you pay it back. 

That said, you’ll still want to consider paying the loan back at your earliest convenience to avoid hefty interest charges.

Disadvantages of borrowing against your policy

1. You have to wait for cash value to build up

Since your life insurance policy’s cash value is the loan’s collateral, you have to wait for the cash value to build up enough for you to borrow against. 

It can take a long time for this to happen, often upwards of 10 years, meaning the option to borrow won’t be available right away. To give you an idea, here's the average rate of return on a whole policy compared to other avenues:

comparing rate of return on whole life insurance to other investments - borrowing against life insurance canada

2. You can lose your coverage if you don't pay

The interest on your loan will accumulate if you don't pay and may exceed your policy's cash value. Your insurer may then have to dig into your policy's death benefit to recoup their loss.

You may think you're just borrowing from yourself, but you also want to make sure you're not borrowing from your loved ones, too, when they need that financial safety net most.

3. Your only options are whole or universal life insurance

If you want to take advantage of this option, you need to have a whole or universal life insurance policy in place. 

These types of life insurance policies cover you for your whole life. But universal and whole life insurance premiums are expensive and provide more coverage than most Canadians need. 

This is especially true if your main reason for getting life insurance is to protect your financial dependents rather than passing down large assets.

Why you should consider term life insurance instead

For most Canadians, term life insurance is the way to go. Whole and universal life insurance may offer perks like borrowing against your policy later on, but it's not necessarily the best choice for your finances. 

The premiums for term life insurance in Canada are significantly cheaper than whole, which means you can use the extra money at your discretion instead of worrying about repaying interest on your own money!

With a term policy, you invest or put the difference in a TFSA or RRSP account, giving you more control over your cash.

borrowing against life insurance - whole versus going with term and investing the rest

And your insurance needs will change as your family's situation does. Why tie up your funds in a policy that may not be worth it long-term?

With term life insurance, you're covered for the term length you need, like when your kids are young and financially dependent on you.

How soon can I borrow against my life insurance policy?

You can borrow against your life insurance policy as soon as your policy has built up enough cash value to do so. While the exact timeframe depends on your policy’s terms, it typically takes at least a decade to accumulate enough cash value.

What is the interest rate on a life insurance loan?

The interest rate on a life insurance loan varies depending on the life insurance company you’re with, your policy’s terms, and whether your interest rate is fixed or variable.

That said, interest rates for borrowing against life insurance are typically between 5-8%.

How much can you borrow against your life insurance policy?

It’s different for every insurer, but you can typically borrow an amount close to the total cash value, with most insurers allowing you to borrow up to 90%.

FAQ: Borrowing against life insurance in Canada

Can you take out a loan against your life insurance policy in Canada?

Yes, it is possible to take out a loan against your life insurance policy in Canada, but only if you have a permanent life insurance policy like whole life or universal life insurance.

Is money borrowed from life insurance taxable in Canada?

Like your policy's death benefit, money borrowed from life insurance is not taxable as long as the policy is still in force. Your loan will become taxable, however, if you surrender your policy or your policy lapses and the amount owing on the loan exceeds what was paid into the policy.

What is the cash value of a life insurance policy?

Life insurance's cash value is related to the investment component of the policy — if applicable. Some life insurance policies don't offer cash value, so it'll depend on the kind of life insurance you have. In most cases, cash value is offered in permanent life insurance plans like whole life and universal life. But not all types of permanent life insurance coverage have it!

Why do experts say that life insurance loans are risky?

Many insurance experts believe that it is too risky to take a loan from your life insurance because it has an impact on the coverage amount (death benefit/lump sum payout). If you pass away before you've paid the loan back, your loved ones won't get the full death benefit amount that you initially signed up for, causing potential financial strain on them.

To be fair, there are inherent risks with taking on any kind of debt, but borrowing against your life insurance may leave your family in a tough spot.

Laura McKay

COO & Co-Founder
About the Author

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