If you need money urgently without necessarily selling your assets or investments, a loan against insurance policy is a suitable choice. The loan is backed by your life cover policy surrender value and thus enables you to fund with maximum ease. It is a brilliant financial tool in times of exigency or future expenses for most individuals.
But something to be kept in mind when taking such a loan is the calculation of interest on the loan against life insurance policy. The interest rates have a direct impact on your cost of borrowing and repayment, so it is better to know how they are calculated. This step by step guide will assist you in understanding the most important determinants which are considered by financial institutions and banks while computing interest on insurance policy loans. Going through it will leave you more assured about the correct decision to invest this money utility efficiently.
How a loan against insurance policy operates
Before delving into the variables that set the interest rate, having an idea of the general concepts involved in a loan against insurance policy is helpful. In India, most life insurance firms permit policyholders to borrow against the surrender value of life insurance policies, endowment or whole life policies with cash value that accrues over a period of time.
You can go to your insurance company or financial institutions like Bajaj Finance to select such loans. The loan amount would generally depend on the surrender value, the higher being the policy term, the more it would be. Loan against insurance policies is a secured loan compared to unsecured personal loans because your policy itself is being used as security.
There is no credit check and income verification, as your loan is less risky for the lender. Interest rates on such loans are lower than credit card loans or personal loans because of this security.
The most important thing here is that the insurer continues to pay your policy premium either by revising the loan EMI or paying your outstanding benefit amount so that the policy never matures. But in case you fail to repay the loan, the insurer can make the dues payable from the policy proceeds upon maturity or surrender.
Short of a mortgage, it is an excellent way of borrowing money at short notice for reasonable interest rates with minimal inconvenience – and hence a winner with cash-short families.
Issues that decide the loan against life insurance policy interest rate
Understanding of the loan against life insurance policy interest rate includes understanding of a number of factors considered by the lenders before offering a rate. The factors bring the loan reasonably priced in terms of risk and insurer conditions.
Type of life insurance policy
The kind of life insurance policy that you hold is a determining factor in deciding the rate of interest. Policies that leave behind higher surrender values such as endowment or whole life policies have lower interest rates by nature. That is because they provide the lender with collateral security that is stable.
Term policies are not surrender value and hence cannot be borrowed against. Where your policy is a ULIP, variable fund values will have an impact on the terms of the loan in terms of the changing value of collateral.
Loan amount and loan-to-value (LTV) ratio
One of the key interest-rate drivers is the ratio borrowed against your policy’s surrender value, and this is referred to as a loan-to-value ratio. Borrowing is typically available at a ratio of between 80-90% of the surrender value.
If you need a greater proportion of your surrender value, the lender will treat this as a riskier option and will increase the rate of interest. Lower LTVs will be safer and will be provided with more favorable rates.
Loan tenure
For how long you borrow the money is also a factor. Shorter terms have lower interest rates because the lender’s duration of risk is shorter. Long tenor loans would have slightly higher rates to cover longer risk and inflation durations.
In India, the tenor of insurance policy loans is generally 12 to 60 months. Choose the tenor wisely based on your repayment capacity as longer tenors can result in more interest paid over the tenure though EMIs are lower.
Lender policies and market conditions
Various institutions have varying lending approaches. A financial institution such as Bajaj Finance may have more concessional rates than the rest of the banks or NBFCs, depending on their risk appetite and product approach.
The market prevailing rate of interest and monetary policy of Reserve Bank of India also have equally significant roles in determining these interest rates. You can get a lower cost of the loan during low policy rates.
Borrower’s credit record
Although policy loans are collateralized and less credit-oriented than unsecured loans, the lender will still have some impression about your creditworthiness. A good credit history is an asset when you can qualify for a minimum rate of interest.
Where you do have negative credit record or ongoing defaults, there are lenders that will charge a higher rate of interest instead of perceived higher risk.
Outstanding loan on the policy
In case you already have a loan against the same policy, then the amount of outstanding loan on the loan will be determined by the lender before lending further loans. Multiple loans or large outstanding dues are of greater risk and may have to pay higher interest charges or loan limits.
Partial or complete loan
It does not matter if you borrow partial loan under your policy or surrender the total surrender value, it also fixes the interest rate. Small amount part loans have smaller rate than other term full surrender loans.
Benefit of taking loan against insurance policy at low interest rate
If the loan against life insurance policy rate is knowledge that you have for your own use to help you get the best deal, then the reason why the rate makes a big difference is something that you might be thinking about. Here are some advantages of borrowing with a low rate on such loans:
- Low-cost borrowing: For unsecured borrowing, a low interest rate saves you on your cost of lending, and as such you pay less money in the long term.
- Convenient finance: You still have protection and benefits when the policy is active, and the policy’s cash value as security.
- Simple approval: Lower risk for the lender, usually translating to faster processing with less paperwork.
- Enhanced liquidity: Low-interest financing allows you to finance temporary requirements without dipping into savings or other investments.
- Tax benefits: The interest on some insurance policy-backed loans may be tax-favored, although that would depend on the policy and loan.
By prioritizing factors like loan term, LTV ratio, and lending policies, the borrowers have an opportunity to negotiate or access such facilities which offer the best interest rate. It not only keeps the loan against the life insurance policy within reach but a feasible option during a financial crisis.
Tips to get the lowest interest rate on loan against policy of life insurance
To get the lowest available loan against life insurance policy interest rate, follow the prudent steps:
Extend the policy term
The longer policy duration you maintain, the higher the surrender value and the lower the risk for the lenders. It typically translates into better interest rates.
Borrow in moderation
Don’t borrow close to the maximum surrender value. Small loan size against your policy value is safer and incurs lesser interest rates.
Shop around for lenders, prices
Don’t take the first lender. Compare rates and terms at banks, NBFCs, and insurance companies. Bajaj Finance offers competitive rates and simple procedures.
Improve your credit score
Even for secured loans, there is visible credit history to enjoy lower rate of interest through demonstrating payment discipline.
Go for shorter period of loan
Going for shorter period reduces the interest burden and even induces lenders at times to offer lower rates.
Don’t take multiple loans on a single policy
Pay out outstanding clear dues in advance prior to taking a new loan in order to enjoy lower rate of interest.
Be papers prepared and current
Comprehensive, correct documentation reduces processing and benefits offers.
Conclusion
Life insurance policy loans enable the customers to fulfill short-term or long-term financial needs at negligible and trouble-free costs without having to make productive investments sacrificial. The skill of making maximum use of this facility is in knowing what decides the rate of interest of the loan against life insurance policy.
Some economic aspects such as type of insurance policy, loan worth against surrender worth, duration of the loan, lender’s behavior, and your financial record all determine the interest rate you pay on the loan. Keeping this in mind, you can select or bargain best rates and make the loan workable while meeting your cash requirement.
Such companies as Bajaj Finance facilitate this with decent interest and easy terms. Accordingly, if ever you are in a position to require instant money at the cost of losing your financial stability, a loan against policy is something to consider seriously.
