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A policy loan is available only on policies that have accumulated cash value. The policyowner may borrow up to the amount of available cash value; any loan balance and accrued interest that remains unpaid is subtracted from the proceeds when the insured dies. An outstanding policy loan will not, by itself, cause the policy to lapse unless the loan and its accrued interest grow larger than the available cash value — and even then, the insurer must give the policyowner 30 days' written notice before the policy is allowed to lapse. Insurers may delay a policy loan request for up to 6 months, though a loan requested to pay an overdue premium must be honored right away. Policy loans are not subject to income tax.
Policy loans are available only on policies that have cash value.
Any policy with cash value also has loan value. The amount available to borrow equals the cash value minus whatever loans (and accrued interest) are already outstanding:
Loan value = Cash value − (unpaid loans + interest)
If a loan is still outstanding when the insured dies, that balance is treated as a debt against the policy, and the death benefit paid to the beneficiary is reduced by the amount owed.
Marcus owns a whole life policy with a $200,000 face amount. Four years ago he borrowed $40,000 against the policy's cash value, and that loan has since accrued $2,800 in interest. If Marcus dies today, the death benefit paid to his beneficiary will be $200,000 − $40,000 − $2,800, or $157,200.
The automatic premium loan provision is optional, but insurers commonly add it to cash-value contracts at no extra charge. Its purpose is to keep a policy from lapsing by mistake when a premium goes unpaid: once the grace period for a due premium runs out without payment, the insurer automatically generates a loan against the policy's cash value for the amount of the missed premium, and that loan accrues interest like any other policy loan. If the loan and interest are never repaid and the insured later dies, the balance is simply deducted from the death benefit. While the insurer may defer other loan requests for up to 6 months, a loan generated to cover a due premium must be processed immediately. Because this provision changes how the policy behaves, the policyowner generally must elect it in writing for it to take effect.