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You’ll often come across people talking about different types of loans in India, but rarely would you hear about a loan against insurance policy. One primary reason for this, is unawareness, and the other, India’s insurance penetration, which is well below the global average.
Loan against insurance policy, also known as pledging, is an extremely popular concept abroad. Such loans are issued by the insurance companies itself, or any other financial institutions that provide loans against securities. This type of loan bodes well for loan seekers as you don’t have to provide any other assets as collateral. Therefore, instead of taking personal loans or loans against your credits cards, you can choose to borrow money using your insurance policy. However, such loans are not available against term insurance policies or equity-oriented securities.
You cannot avail loan against every type of life insurance policy. Hence, it is better to check with your insurance company prior to buying a plan. But policies like whole life policy, money-back policy, and endowment plan provide a loan against life insurance policy. Sometimes loan can also be taken against Unit-Linked Insurance Plan (ULIP) depending on your insurer.
Some benefits of loan against insurance policy are:
I. Lower Interest Rates: Interest rates on this type of loan is much lesser when compared to the interest rate levied on a personal loan.
II. Quick Disbursement: As the documentation is minimal, the disbursement of the loan is quicker with limited application processing required.
III. Fewer Chances of Rejection: Unlike unsecured loans, there’s a slim chance that your loan application will get rejected as you hold an insurance policy with the company.
IV. Less Scrutiny: As the insurance company has your life insurance policy as security against the loan, there is less scrutiny. Also, your CIBIL score is not closely examined for sanctioning the loan which is beneficial if you have a low CIBIL score.
People who hold a life insurance plan and/or ULIPs (Unit Linked Insurance Plans) can apply for this loan. Unlike the traditional insurance policies, ULIPs offer life insurance risk covers that provide options to invest in areas like shares, stocks and bonds. Therefore, if you are planning to apply for a loan of this kind in the future, you must buy life insurance first.
II. Rate of Interest
The interest rate charged on this type of loan depends on the interest rate applicable at the time of taking the policy. The borrower has to pay interest for a minimum of 6 months even if the loan has been cleared before within this time frame.
The repayment period is usually 6 months. But the terms and conditions of repaying your loan may vary based on your lender. For instance, some insurance providers do not require the borrower to pay the principal amount. Instead, at the time of maturity or claim, they directly credit it from the policy value, provided you are paying the interest amount on time.
IV. Surrender Value of Policy
Your life insurance policy acquires a surrender value if you have been paying your premiums on time for 3 years of buying the policy. The time period for acquiring a surrender value may differ according to your insurer. But you cannot avail a loan if your policy doesn’t have a surrender value.
V. Loan Amount
The eligible loan amount that you can borrow has to be checked with your insurer. The loan amount is a percentage of the surrender value with the loan being of up to 85-90% against traditional life insurance plans with guaranteed returns.
VI. What Happens If You Fail to Repay?
If you fail to repay the loan taken against life insurance policy then the interest keeps adding to the balance amount. If the loan amount exceeds the insurance policy’s cash value then this can cause the policy to lapse. The insurer will then have the right to recover the loan amount and interest from the surrender value of your policy and terminate the insurance.
VII. What Is the Drawback of Availing Loan Against Insurance Policy?
The drawback of loan against a life insurance policy is that in the event of your death, the beneficiary will receive the death benefit but will not be able to recover the entire policy amount. The insurer will deduct the outstanding loan amount and interest before paying the death benefit.
VIII. How to Apply for Loan against Life Insurance Policy?
The process for applying for a loan may differ from one insurance company to another. But you can contact your insurer to enquire about the surrender value of the policy, the eligible loan amount and the terms and conditions related to this feature.
To avail this loan, you need to fill a loan application form, which needs to be accompanied with the original insurance policy document. You will also need to attach a copy of a cancelled cheque and a payment receipt for the loan amount.
Thus, before you plan to avail this type of loan, you are recommended to speak to an insurance advisor so that you can fully understand the terms and conditions of the loan. This will make you well aware of the short-term and long-term risks attached to it.
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