Loan Against Insurance Policy

Loan against Insurance Policy is not so very common in India. One of the major reason is that the most of the policyholders are not aware of this option. Secondly, the penetration of insurance is very low in India. In fact, i believe that if we remove Income Tax benefits attached to the Insurance Policy then penetration will be negligible. Insurance Premium is either considered as a waste of money or is paid for investment purpose. Both, India psychic and Insurance industry are responsible for this sorry state of Insurance products. By now most of my readers know that i have traditional insurance policies. I keep sharing my pain in my posts related to insurance as i always suggest to keep insurance and investment objectives separate. Recently, i took Loan against Insurance Policy to understand how it works. I was not in a need of funds but as i have a habit of experiencing the subject before i share with my readers. Loan against Insurance Policy is also known as pledging which is a very popular concept in western countries.

In India, if you tell someone that you are mortgaging / pledging your assets then the 1st reaction is as if a person has gone bankrupt. When my father came to know about my Loan against Insurance Policy, he offered financial support to me. I explained to him that i am not in a need of money but opting for Loan against Insurance Policy to experience the process. He took promise from me that i will close this loan within 1 month or so. Honestly speaking, no one in my family understand what i do. They think that i am some poor writer :). Anyways, my apologies for digressing from the main topic.

What is Loan against Insurance Policy?

Let me clarify that you can avail Loan only against Life Insurance Policy. Only exceptions are Term Insurance Plan & ULIP. Pre-condition is that Life Insurance Policy should have completed 3 years. In short, traditional insurance policies like Endowment Plan, Money back policy etc are eligible for Loan against Insurance Policy provided policyholder is paying the premium for 3 years. IRDA banned loan against ULIP in 2012. Some insurance companies do provide loan against ULIP but it depend on the fund you have selected & NAV of the ULIP. For ULIP, the loan amount is 40%-50% of Fund Value. As a thumb rule, for any life insurance policy which has the surrender value, you can take Loan against Insurance Policy. Surrender Value is basically the amount which the policyholder will get if he/she decides to close the insurance policy before maturity. The surrender value of policy keeps increasing with the policy term depending on your insurance product as you accumulate bonus over a period of time. Normally surrender value of the policy is 30% of the Policy Value. Loan against Insurance Policy is one of the best way to raise funds during emergency situation. You can avail loan from your insurance provider or pledge the policy to banks. 

Loan Against Insurance Policy – Snapshot

Loan Amount: Its a complex calculation which depend on Surrender Value of the Policy, No of Premiums Paid & No of years Completed / Remaining. There is no scientific calculation to arrive at Loan Amount. As a thumb rule, you can assume that 80%-90% of the surrender value can be availed as Loan Against Insurance Policy. For example, if your insurance coverage is Rs 10,00,000. The surrender value will be Rs 3,00,000 therefore you can avail a loan of between 2.4 Lakh to 2.7 Lakh. If you have accumulated an additional bonus of Rs 1 lakh then Loan eligibility will be approx 3.2 Lakh to 3.6 Lakh. Another method which is used by LIC to calculate loan amount is approx 50% of the premium paid. Assuming, for a policy of Rs 10 Lakh, you have paid a premium of Rs 8 lakh at the time of availing Loan Against Insurance Policy. You can get a max loan of Rs 4 Lakh. Normally, Insurance provider will not share how they have calculated loan amount but it is the FINAL WORD.

Rate of Interest: The interest rate charged by the insurance company is variable and depend on the existing interest rates. Currently, it is around 10% – 12%. Interest is payable every 3 months, 6 Months or yearly basis. In some cases, there is min commitment period of say 6 months. The borrower has to pay interest for min commitment period even if the loan is cleared before 6 months. Please note that Interest Rate is variable and is revised annually. 

Documents Required: You need following documents to avail Loan against Insurance Policy

(a) Original Insurance Policy

(b) Deed of Assignment: Under Deed of Assignment, the benefits of life insurance policy against which the loan is taken will be assigned to the bank or insurance company. The policy will act as collateral or security till the loan is repaid. The assignment can only be executed by the policyholder and it has to be endorsed on the policy document. In short, you transfer the title of the policy till the loan is repaid. Future premiums are paid by the policyholder only.

(c) Payment Receipt for the Loan Amount: Normally, the Loan is disbursed through NEFT therefore advance receipt is required

(d) Cancelled Cheque

For sample Application form of Loan Against Insurance Policy, CLICK HERE

Repayment Options: Repayment options also vary. For example, in case of insurance provider like LIC you need not pay the Principal amount provided you are paying the interest on time. Now you must be wondering how will insurance company recover the principal amount. At the time of maturity or claim, principal outstanding will be deducted from the policy value. Balance amount will be paid to the beneficiary or policyholder. If the policy is pledged to a bank then you need to pay the principal amount as per amortization schedule. Normally, the repayment period is 6 months.

Loan Processing Fees: A nominal fees of Rs 250 is charged.

Time Taken to Process Loan: Banks and Insurance provider claim that the loan will be processed in 2 days time, but it may take up to 7 days time.

Default on Repayment of Loan / Future Premiums: In case of default in repayment or payment of future premiums, the insurance policy will lapse. The insurance company also reserves the right to recover the principal / interest due from the surrender value of the policy. The threshold is surrender value of the property i.e. if principal + interest outstanding equals to surrender value then your policy will be terminated.

Loan Closure: Upon the repayment of Loan, Insurance Provider or Bank will reassign the policy to the policyholder by an endorsement in the policy.

Insurance Provider or a Bank?: Some people are in a dilemma whether to avail Loan against Insurance Policy from a bank or Insurance Provider. I will suggest availing Loan against Insurance Policy only from the insurance provider. The reasons are

(a) You need not repay Principal which will be adjusted from Maturity / Claim amount. Though it is not advisable but still, it can be an option in case of emergency.

(b) Banks charge higher interest rate

(c) The loan from a bank is basically overdraft facility against the pledging of an insurance policy. Any overdraft facility is reported to CIBIL. If you default on Loan against Insurance Policy from the bank then it will impact your CIBIL score negatively.

Benefits of Loan against Insurance Policy

(a) CIBIL Score:  As i also mentioned in my post, How to avail Home Loan without CIBIL Score? that CIBIL Score is not checked for Loan against Insurance Policy. Therefore, people with low CIBIL Score can also avail the loan.

(b) Alternative to Personal / Consumer / Short Term loan: Loan against Insurance Policy is best alternative to low-value loans like Personal Loans etc. Reason being, interest rates are lower compared to unsecured loans. The interest rate on a personal loan is average 14%, but the interest rate on Loan against Insurance Policy is 11%.  

(c) Chances of Application Rejection: There is no fear of application rejection except on technical grounds like signature mismatch etc. Whereas in unsecured loans income details, credit worthiness etc are checked therefore chances of rejection of an application are high.

Summary: Insurance policy provides financial security to dependents in case of any unfortunate event. Loan against Insurance Policy should be the last option for a policyholder. It should be availed only for emergency situations. Even if the loan is availed, it should be repaid within 6 months – 1 year so that benefits of the policy can be restored.

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