Can Life Insurance Really Help Me Buy a Home?
If you dream of one day purchasing a home, a permanent life insurance policy offers a way to provide cash for a down payment.
Quick take: Life insurance to build up cash value for a home purchase
• Permanent life insurance policies, which insure you for your entire life , are structured to accumulate cash value that can be borrowed against .
• You can use this money for a wide range of purposes, including making a down payment on a home.
• You can avoid the hassle of going to a traditional lender by borrowing from your insurer and using your policy’s cash value as collateral.
• The money you borrow generally isn’t taxable3 because it’s not considered income by the IRS.
Q. I’m a first-time homebuyer… or, I hope to be one day. For now, I’m a first-time home saver, which is much harder than it sounds. I heard that I may be able to tap life insurance to contribute to my initial down payment, which seems complicated. What should I know before borrowing against a life insurance policy to make a down payment on a home?
We posed this question to Deborah Curtis, a Farmers Insurance® agent based in Turlock, California. Here’s her advice on tapping into a life insurance policy’s cash value for a home down payment or other purchase.
A. I know it can seem complicated, but the fact that you know life insurance is an option for home savers puts you ahead of the game. I will try and help make sense of the ways in which life insurance can come in handy for homeowners and would-be homeowners.
When you buy a life insurance policy, you choose between two basic types of coverage: permanent and term. Permanent or whole life insurance protects you throughout your life as long as premiums are paid. Once you buy a whole life policy, your monthly premium won’t go up, even if you become seriously ill. Best of all, permanent life insurance accumulates a cash value over time, from which you may be able to borrow for a variety of uses. In addition to helping to protect your family financially in the event of your death, life insurance can be an important financial resource during your lifetime.
Even more flexible than a traditional permanent life policy is something called universal life, which may allow you to pay extra money into the policy to accumulate greater cash value from which to borrow over time.
Term life insurance is different. It is offers level premiums for only a fixed period, such as 10 or 20 years, and pays out only if the insured passes away during the policy term. Term life is generally less expensive to purchase than permanent life, but it doesn’t build a cash value you can borrow against, and premiums will increase after the level premium period.
“Does it hurt your policy to borrow from its cash value?”
It’s important to remember this isn’t free money. A loan against your life insurance policy is just that, a loan. Once the money is borrowed, the insurance company will charge you interest as long as the debt is outstanding. An unpaid loan will reduce your policy’s death benefit. If you keep a policy loan in force, the company charges interest, and that gets added to the balance of the loan. There's no requirement to pay interest, you don't get billed for it separately, but it accumulates and continues to eat into your death benefit.
“Are there other benefits of borrowing against a life policy?”
Borrowing from the cash value portion of your life insurance to make a down payment on a home, or for other purposes, can have a tax advantage. I’m not a tax advisor, and I recommend you speak to one you trust before making any big tax decisions, but I know loans or partial surrenders of any amount are generally income- tax free up to the amount of the premiums you’ve already paid. If the payout is less than the money you have put into your policy, it’s generally not taxed.
“Are there other ways to access the cash value of your life policy?
If you don’t want to borrow against your policy, another option is to simply surrender part of your policy for its cash value. However, that will reduce the cash payout to your beneficiaries when you die.
“What happens if you surrender your policy for the cash value?”
If you surrender a permanent life policy, you can receive the cash value, but it will end the insurance coverage. In some cases, this could also result in paying a surrender fee to the insurance company. Also, you may have to pay taxes on any amount that exceeds your cash basis, the sum of all of your insurance premium payments.