If you have a life insurance policy, it could help you buy a house in a couple of ways:
- Lenders may accept your policy as a form of collateral. By putting up your life insurance, you could improve your chances of qualifying for a mortgage and at a lower interest rate.
- If your life insurance policy has cash value, you could take that money out through a loan or withdrawal and put it toward your home purchase.
Key Takeaways
- Life insurance can help you buy a house. You could put the policy up as collateral for a mortgage, or, if you have permanent insurance that has built up cash value, you could tap that to pay for the home.
- If you use your life insurance as collateral and die before paying off the mortgage, the lender collects from the death benefit.
- Putting up collateral could improve your chances of qualifying for a mortgage as well as possibly getting it at a lower interest rate.
- You can take cash value out through a withdrawal, a loan, or cancellation of your policy. Each has pros and cons.
How to Use Your Life Insurance to Buy a House
Collateral Assignment of Life Insurance
One way to use your life insurance to buy a house is by using the policy as collateral for the mortgage. Collateral is a valuable asset put up to secure your loan. If you don’t pay off your debt, the lender collects from the collateral instead.
In a collateral assignment of life insurance, you secure the mortgage using your policy’s death benefit. If you die without paying off the mortgage, the life insurance death benefit pays off your debt first. If there’s any money left over, it then goes to your heirs.
When you put up life insurance as collateral, a lender could be more likely to approve your mortgage application. They also might approve you for a lower interest rate, reducing how much you need to pay per month and over the course of the loan.
The type of life insurance matters for collateral. Lenders are more likely to accept a permanent life insurance policy like whole life, universal life, or variable universal life. These policies don’t have an expiration date. They last your entire life, as long as you keep paying the premiums.
Alternatively, term life insurance has a set expiration date. For example, a five-year term policy lasts five years. If a lender accepts a term policy as collateral, the policy typically must last at least as long as your mortgage.
If you don’t already own life insurance, you could buy a policy to put up collateral. For suggestions, see our review of the best life insurance companies of 2023.
When you sign a collateral assignment agreement with the lender, you agree to keep your life insurance policy and continue making all the premium payments. You’ll need to notify your insurance company about the arrangement as well. If you cancel your life insurance policy, your lender could increase your interest rate. If your policy has cash value, the agreement could restrict your access to it until you’ve paid off the loan.
Life Insurance Cash Value
Some permanent life insurance policies offer cash value. This is money that builds up in your policy from your premium payments. The insurance company also provides a return on your cash value balance. If your life insurance policy has cash value, you could take this money out to help buy your house by putting it toward your down payment or future mortgage payments.
Term life insurance policies don’t build cash value. If you own one of these policies, it will not give you cash that you could use to buy a house. These temporary policies only offer the death benefit.
Taking the Money Out of the Policy to Buy a House
You have several ways to take money out of a life insurance policy to put it toward a house. Each has different rules, advantages, and disadvantages.
Withdrawal or Partial Surrender
One way to take cash value out of your policy is through a withdrawal. Your insurance company will tell you how much you can take out. Through a withdrawal/partial surrender, you keep your life insurance coverage. You take out cash value but then continue paying premiums to build it again for the future.
A withdrawal is simple and maintains your life insurance protection. You can withdraw up to what you paid in premiums without owing taxes. However, if you withdraw gains above what you paid in premiums, you will owe income tax on your earnings.
You can’t repay your cash value withdrawal. Your future life insurance cash value growth will be lower after a withdrawal because there’s less money in the policy to invest. In addition, a withdrawal reduces how much your heirs receive for a future death benefit.
Take a Loan
Life insurance policies let you borrow the cash value with a loan. The life insurance company charges interest on your outstanding cash value loan. This rate is typically lower than what you would owe on most personal loans. You can then pay the life insurance loan back at your convenience.
Note
With a life insurance loan, you don’t owe income tax for taking money out. This applies even if you borrow your gains. If you repay the loan, your cash value will continue to grow at the same rate as if you hadn’t taken the money out.
The drawback of a loan is that the insurance company will charge interest, adding it to your outstanding debt over time. If the outstanding loan balance exceeds your cash value, the insurer could cancel your policy. If you die without paying off the loan, the insurer will deduct this amount from your death benefit. Anything left over would go to your heirs.
Full Surrender
In a full surrender, you cancel your life insurance policy. The life insurance company will send you your entire cash value balance. If you receive more than you paid in premiums, you’ll owe income tax on the gains. Some insurers also deduct an additional surrender charge from your balance, depending on the policy conditions.
With a full surrender, you don’t have to cover future life insurance premiums or pay interest on a cash value loan. The downside is that you completely give up your life insurance coverage. This could make sense only if you’ve decided that you no longer need the life insurance policy.
How Soon Can I Borrow Against My Whole Life Insurance?
You can borrow against your whole life insurance once you have built cash value. Most policies take two to five years to start building cash value, so by then, you could take a loan. Your insurance company may have a minimum loan size requirement. If so, your balance would need to be at least this large before you can borrow.
How Much Money Can I Borrow from My Life Insurance?
Most life insurance companies set a limit saying you can borrow no more than 90% of your total cash value balance. The more you have in cash value, the more you can borrow. The exact loan maximum limits depend on your insurance company.
Can I Use My Life Insurance to Build Wealth?
You can use permanent life insurance policies like whole life, universal life, and universal variable life to build wealth. These policies generate cash value from your premiums. In addition, the insurance company pays a return, so your cash value grows over time and creates wealth. On the other hand, temporary, term life insurance policies don’t offer cash value and don’t build wealth.
How Long Does It Take to Build Cash Value on Life Insurance?
Permanent life insurance policies typically take two to five years to build cash value. The rate depends on the type of policy and your premium payments. When you apply for life insurance, you can request an illustration showing how long it will take to build cash value.
The Bottom Line
Life insurance can be used to buy a house. You can use your policy as collateral for a mortgage loan. If your policy has cash value, you could also take the money out for your home purchase. These financial strategies aren’t just limited to buying a house. You also could use them to buy a car, cover medical bills, or to pay for a vacation. Keep these strategies in mind if you own life insurance.
