Borrowing against a life insurance policy has grown very popular over the last decade but while there are a number of benefits to this strategy, there are also quite a few consequences as well.  Permanent or universal life insurance policies are made of two components, the death benefit or face value of the policy and the cash value or investment component.

The cash value component is considered an asset so you’re able to use it as collateral for a loan.  Insurance companies will usually let you borrow up to 90% of the cash value of your policy.  A bank can also be used for this as well if they are placed as the beneficiary for the loan amount.

The benefit of borrowing from your own policy is that there is no set repayment schedule so it can offer a lot more flexibility than a regular private loan.  The interest rate will also tend to be lower since there is practically no chance of default.

Theoretically it is possible to not have to pay the loan back until death but that is not recommended.  The loan amount will grow over time as interest is compounded and this is where the danger comes in.

In a bearish market like we currently have, it is quite possible for the loan amount to grow at a faster rate than the cash value component.  If the loan amount ever goes over the cash value amount, one of two things will happen.  Either the borrower pays the difference to the lender to keep the loan amount below the cash value component or the policy lapses.

If a policy is allowed to lapses, what happens is a cash surrender where the cash value amount is paid out, which can have significant tax implications.  Also the death benefit component will now be forfeit which is the main reason you buy insurance in the first place.

Let’s say that you have $100,000 in your cash value account and borrow $75,000 of it from your insurance company.  This doesn’t reduce the cash value component of the policy to $25,000 as the loan is not considered a withdrawal, it’s still at $100,000 and will continue to grow at a tax deferred rate..

Then let’s say you chose not to repay the loan and that eventually over time, both the loan amount and cash value have grown to $300,000 when the policy finally lapses.  The cash surrender value then becomes fully taxable as income by the IRS at whatever tax bracket you are in.

It is quite possible, if you are in a high enough tax bracket and if the loan was for a long enough duration, that the taxes owed may be more than the original amount borrowed.  So even though you only borrowed $75,000 initially, you will be responsible for paying taxes on the full $300,000 amount of the cash value component.

It is very important to talk to a credible financial planner and make an informed decision before entering into this type of loan agreement.

Many Americans are overpaying for home and car insurance and don’t even know it.  It is important to review your policies at least once a year.  Here are a few things that anyone can do to help save money on their insurance.

Compare prices

Property and auto insurance rates have been on the decline recently, so it might be good time to shop around and see if you can’t get a better deal somewhere else.

Purchase the proper amount of coverage

For homeowner’s insurance especially it is important to get an accurate value to what you are insuring and the amount of coverage you actually need.  Instead of using property value as the basis for coverage amounts you should use the estimated replacement or reconstruction costs.  With housing prices in a sharp decline, some people may actually be under insured.

Increase your deductible

It can increase what you pay for an incident but it can significantly lower the cost of your premiums.

Use a single insurer

In some cases it may be cheaper to get both types of coverage from a single insurer.  Check to see which companies offer package deals.

Look for discounts

Many companies offer discounts for a variety of different reasons.  For instance, a company may offer government employees a special discount. Make sure you receive any that you might be entitled to.

With the tax deadline fast approaching many recent  home buyers may not be aware that premiums for private mortgage insurance(PMI) paid in 2007 are tax deductible as mortgage interest.  It was included as a provision in the Tax Relief and Health Care Act of 2006.

Banks would normally require home buyers to purchase private mortgage insurance, when they have less than a 20% for an initial down payment.  The tax change was primarily approved as a way to help out mortgage insurance companies, who were losing out on business because it was cheaper for most people to take out piggyback loans.

People were avoiding the PMI by basically taking out two mortgages, one for 80% and another for the remainder.  Since the interest payments for both mortgages were tax deductible, it was usually a cheaper alternative to the PMI which could be quite expensive depending of the credit rating of the borrower and the amount of the initial down payment.

After the changes took effect the purchase of PMI became viable again because the piggy backed mortgage would normally have a much higher interest rate than the primary mortgage.  Although housing prices have fallen sharply many families are still unable to afford the regular 20% down mortgage so the tax changes benefits a significant number of lower income households.

Unfortunately anyone that purchased a home prior to 2007 won’t qualify for the deduction unless they had refinanced their mortgage last year.  Also, only those households with an adjusted gross income of $100,000 or less qualify for the full deduction.

While the tax break was initially to last only a year the deduction was extended for three more years in the Mortgage Forgiveness Debt Relief Act of 2007.