Introduction
A life insurance policy is structured to provide protection to your family in case of your unfortunate death. In return for paying regular premiums, the insurance company promises to pay a lump sum to your nominee if something untoward were to happen to you during the policy term.
That said, life insurance is also a tax-efficient savings instrument for millions in India, and can therefore act as collateral in times of financial need. Policyholders can take loans against their life insurance policies to meet urgent needs such as medical expenses, education costs, business expenses, or other personal emergencies.
If you are a policyholder considering taking a policy loan, but worried about “what happens if I die after taking a loan on my life insurance policy?”- This piece is for you.
How Loans on Life Insurance Work
You can take a loan on eligible life insurance policies — this includes most traditional policies such as endowment plans, money-back plans, guaranteed income schemes, and unit-linked insurance policies (ULIPs) that have built a surrender value or fund value over time. The loan amount is usually a percentage of your policy’s surrender or fund value. The exact value depends on how much you’ve paid as premiums and other policy terms, including how old the policy is and what options you have chosen.
Interest is applicable on the loan. Some lenders offer a term loan in which you pay interest and principal each month in EMIs. Others offer an overdraft option, allowing you flexibility in your principal repayment during the term and requiring only monthly interest payments on the amount used or drawn down.
In order to take a policy loan, one must pledge or assign the policy to the lender for the duration of the loan. This gives the lender the right to surrender the policy in case they need to recover any past due amount on the loan extended to you.The benefits of such a loan include:
- A lot more affordable than personal loans or credit cards, with interest rates as much as 10% less per annum than these unsecured options.
- You don’t have to surrender or cancel your policy which incurs a surrender loss, and your savings pot continues to grow.
- You continue to enjoy life cover (protection) while using the loan amount
Loan closure, if all goes well
If you repay the loan during the policy term, the policy is reassigned to you.
- The lender issues a no objection certificate to the insurer, renouncing their rights over your policy
- Your insurers accepts your reassignment request, and the policy is no longer pledged as collateral
- Your life insurance cover continues as usual
- In case something happens to you, your nominee gets the full payout without any deductions related to the loan.
Once the loan is cleared, your policy is fully back under your control, and your family’s protection remains unaffected.
But, what happens if you die with an outstanding loan on your life insurance policy?
If the policyholder passes away during the course of the loan, their family or nominee needs to file a claim with the insurance company as usual. Since the policy is assigned to the lender, the insurance company will first settle the lender’s outstanding dues. This includes:
- The unpaid principal on the loan
- Any outstanding interest or fees on the loan
The insurance company pays the lender directly to clear the loan. After the lender’s dues are settled, the remaining amount is paid by the insurance company to the nominee or family. Where loans are in good standing, the loan dues will typically be a fraction of the death benefit, given the way in which loan amounts are calculated.
In rare cases where the loan is already delinquent and the accrued interest and fees exceed the policy’s payout, the family may receive nothing at all. However this is uncommon, and in most cases, particularly if loan repayments are on track, the nominees will receive a benefit.
Some policies also have the added benefit of forgiving future premiums, so your nominees will also benefit from the maturity value of a growing corpus at the end of the policy term. This is sometimes even bigger than the death benefit. Check the terms in your policy brochure to understand the death benefit terms that apply to your policy.
Example:
Suppose:
✅ Your life insurance sum assured = ₹10,00,000
✅ You took a loan of ₹3,00,000 from a lender by pledging your policy
✅ At the time of your death, total outstanding (loan + interest) = ₹3,20,000
Your family/nominee files a death claim with the insurance company
Since the policy is assigned to the lender, the insurance company:
➤ Pays ₹3,20,000 directly to the lender to settle the outstanding loan
➤ The remaining ₹6,80,000 (₹10,00,000 - ₹3,20,000) is paid to your nominee/family
This way, the lender’s dues are cleared first, and your family still receives the balance amount.
Impact on your family:
Your family still receives the insurance payout, but only after clearing the lender’s dues. This is better than surrendering the policy in times of financial need, as your family would lose the insurance cover entirely and receive no benefit in the case of your untimely passing. Taking a policy loan instead keeps the life cover active (as long as premiums remain up to date), but large unpaid loans reduce the amount your family eventually receives.
Understand the impact of taking a loan before borrowing:
- Keep informed on your policy’s death benefits and the terms and conditions relating to these. Note how they compare to the surrender value or fund value that determine your loan eligibility.
- Borrow only what you need, keeping in mind the possible impact on your family’s future benefits.
- Inform your nominee/family about the loan and assignment, so they are prepared during claim settlement.
- Repay the interest regularly to keep the outstanding loan amount from increasing, which helps protect your family’s payout.