Pledging insurance policy for a loan
The insurance policy that you bought for long-term financial security can help you in a cash crunch too. With interest rates high, and rising, a loan against an insurance policy or a unit-linked insurance plan (Ulip) has many benefits, the biggest being the low interest rate charged.
Eligibility, interest rates
First, check if your policy is eligible for the loan. An individual can avail of loans on all traditional policies, except moneyback plans, if he has paid premiums for at least three years. The interest rates vary from company to company.
"The rate is linked to the market rates and so keeps moving up and down. At present, we are charging 12-12.5%," says Kotak Life's Agarwal.
Insurers have their own criteria to arrive at the rate. Banks link it to their base rates. Banks, unlike insurers, do not charge a fixed rate-it depends on criteria such as the premium paid by the insured, the number of premiums paid.
How to proceed
The first step is to ask the insurance company or the bank the amount you are eligible for. The next is applying for the loan and assigning the policy to the insurer/bank. This means all rights on the policy will be transferred to the lender. The loan is usually sanctioned in two-three days. But this may vary from company to company.
Loan limit
The way the loan amount is calculated is different for Ulips and traditional policies. In the latter, you can get 80-90% of the surrender value, the amount you will get if you exit before maturity. It should be noted that a policy acquires surrender value only after you have paid premiums regularly for three years.
Traditional plans: In traditional plans, you get the higher of the guaranteed surrender value or surrender value, also called the special surrender value. The guaranteed surrender value, which is the minimum amount available as loan, is 30% of the total premium paid minus the first premium amount.
Thus, if you have paid Rs 25,000 as premium for four years and take the loan in the fifth year, the total you have paid is Rs 1 lakh. So, the minimum loan you can get is 30% of 1,00,000'25,000, that is, Rs 22,500.
Thus, in a traditional policy, you can be assured of the minimum amount you are eligible to get.
Let's see what is the maximum amount you can borrow. While you can get 80-90% of the surrender value, including the cash value of bonus, the surrender value itself depends on the insurance company. The amount also depends on the terms and conditions of the policy as well as the surrender value decided by the actuarial department of the insurance company.
Unit-linked plans (Ulips): Not many insurance companies offer loans against Ulips. The loan amount depends on the current value of the corpus. If a Ulip has invested more than 60% assets into equity, you can get up to 40% of the corpus.
If debt accounts for more than 60% assets, the maximum loan amount is 50% of the corpus.
Repayment
The tenure and repayment options differ from insurer to insurer. "The loan can be for the remaining policy term. The insurer provides a repayment schedule. However, customers may pre-pay and foreclose the loan without paying any charges," says Mahajan.
Repayment clauses differ from company to company. In case of some traditional policies, if the insured fails to pay the premium, the policy will lapse. "If the person has taken a loan and fails to pay the subsequent premium, the policy will lapse," said V Srinivasan, chief financial officer, Bharti AXA Life Insurance Company.
Life Insurance Corporation's loans have tenures of at least six months. If you wish to repay before six months, you have to pay interest for the full six months. In case of death of the policyholder or maturity of the policy, the interest will be charged only up to the date of death or maturity.
Pitfalls
Not paying the loan instalments on time can make a huge impact on the policy benefits. This is because if the insured dies, in such a case, the beneficiaries of the policy will get the sum assured after deduction of the pending amount as well as the interest due. If you do not pay interest, the loan amount will become bigger because of the compounding effect and the unpaid amount will be added to your outstanding principal.
"In case of non-repayment of the loan, the insurance company concerned will take the amount owed as interest from the accumulated surrender value of the policy. When the outstanding premium and interest become equal to the surrender value, the policy will be terminated," says Rituraj Bhattacharya, head product development and market management, Bajaj Allianz.
