On unforeseen needs of money, loans are typically assessed through other avenues of credit, such as asset loans, personal loans, or gold loans. A secret but highly convenient one of these channels is credit through a loan against insurance policy. The loan is taken against the surrender value of an insurance policy and is a very good substitute for unsecured loans. The biggest benefit of the loan against an insurance policy is the interest rate, which is lower than that of unsecured loans. Why is the interest rate of loan against insurance policy lower? Let us find out.
Understanding Loan Against Insurance Policy
Loan against insurance policy allows the policyholder to take a loan against his/her insurance policy, using it as collateral. This can be done with policies that carry a surrender value, such as conventional endowment policies and whole life insurance policies. Term insurance policies, to which no cash value is assigned, cannot take advantage of the loan.
Banks and insurance companies offer loans against policies on lower documentation and quicker disbursement. The loan is governed by the surrender value of the policy, which is generally 70% to 90% of it.
Why Loan Against Insurance Policy Interest Rate is Lower?
1. Secured Nature of the Loan
Loan against policy is a secured loan, and the lender gets security in terms of the policy surrender value. In case of default, the amount can be recovered out of the policy proceeds. As unsecured loans are without security, lenders levy higher interest charges to compensate for their risk.
2. Lesser Risk for Lenders
The risk factor is calculated by the financial institutions before choosing the interest rate. Since the policy itself serves as security, the risk factor is significantly less than that of an unsecured loan, where nothing but his or her credit rating is owed by him or her. Due to the fact that the risk factor is less, the lenders lend a lower percentage of interest on the insurance policy loan.
3. No High Credit Scores Required
Distinct from credit rating and history-based unsecured loans, a loan on insurance policy is given on the value of the policy. A borrower with a highly rated credit can be lent at a moderate interest rate. Non-depended credit reduces lender risk and, therefore, interest rates.
4. Policy Maturity Benefits as Security
While issuing loan against insurance policy, the lenders know that the policy will accrue maturity return, and hence, repayment is ensured. This security compels them to offer better interest rates than unsecured loans, for whose repayment everything depends upon the borrower’s income and financial position.
5. Predefined Repayment Structure
Lenders lend against policies on repayment terms of a nature connected to the policy’s maturity. It is repaid automatically from the policy proceeds in some policies, thus allowing lenders to be repaid back. The structured repayment lowers lending risk and the respective rates accordingly.
6. No Extensive Documentation Needed
A loan against insurance policy entails less documentation compared to unsecured loans, which include rigorous credit checking, evidence of income, and employment verification. The process reduces the processing cost, allowing lenders to offer lower interest charges to borrowers.
7. No need for additional collateral
As opposed to unsecured loans, where lenders call for guarantors or other collateral to approve a loan, a loan against insurance policy does away with such. The insurance policy is sufficient collateral, and therefore the borrowing cost is zero.
Loan Against Insurance Policy Interest Rate vs Unsecured Loans
Loan Type
Interest Rate (Approx.)
Collateral Required
Processing Time
Loan Against Insurance Policy
7% – 12%
Yes (Insurance Policy)
Quick
Personal Loan (Unsecured)
10% – 24%
No
Lengthy Process
Credit Card Loan
24% – 36%
No
Immediate
The table clearly shows that the interest rate for a loan against insurance policy is relatively low relative to the rates of unsecured loans since it is backed by a collateral asset and has a relatively low lending risk.
Other Determinants of Loan Against Insurance Policy Interest Rate
1. Nature of Insurance Policy
The policy nature under pledge determines the loan against insurance policy interest rate. Whole life and endowment policies generally offer higher interest rates compared to unit-linked insurance plans (ULIPs) because of guaranteed surrender value.
2. Loan Tenure
Shorter tenor loans would have lower interest charges, while loans of higher tenors could have a little higher interest charges. Due to the consideration of the fact that a loan against insurance policy is typically thought out for short term financial needs, competitive rates exist in comparison to unsecured loans.
3. Loan-to-Value (LTV) Ratio
Interest rate also varies with the amount of the surrender value that can be borrowed (LTV ratio). The more loan paid on the policy value, the more a lender can charge a small premium rate to compensate for the increased risk.
4. Lender Policies and Market Trends
Different money organizations offer different interest rates as per their own criteria, risk absorption capacity, and market situation. Competitively higher rate of interest by bank and insurer enables the borrower to obtain loan against insurance policy on best terms.
Benefits of Selecting a Loan Against Insurance Policy
- Lower Rate of Interest: The rate of interest is less than personal loans.
- Fast Approval & Release: Less documents speed up the process of loan.
- No Impact on Credit Score: As it is a secured loan, credit history is minimal.
- Beneficial Repayment Arrangement: The borrower gets to repay in lump or by EMIs depending on the policy maturity.
- Insurance Benefits Retained: The policy still remains active, and the cover remains as per that.
- No Prepayment Fee: All lenders accept early repayment without charging any extra fees, hence cost-efficient.
- Increased Fiscal Discipline: The borrower is able to borrow against short-term fiscal needs with long-term investments intact.
Conclusion
Loan against insurance policy is a cost-effective method of raising funds since it is a secured loan. The interest on loan against insurance policy is lower than unsecured loans because the lender has an alternative to rely on in the surrender value of the policy. The insurance policy loan is a smart investment for policyholders since it presents benefits such as lower interest, simple repayment, and minimal documentation. If you have a qualifying insurance policy, such a loan will be a perfect alternative to costly unsecured loans. In addition, information regarding factors such as policy type, loan term, and lender policies assists borrowers in gaining the best available interest rate and achieving maximum economic benefits.
