Can I Use Life Insurance for a Down Payment?

Buying a home is a significant investment that requires careful financial planning. One crucial aspect of buying a home is making a down payment, and coming up with one tends to be a source of stress for potential homebuyers. While there are various ways to save for a down payment, you may wonder if you can use your life insurance policy to help cover the costs. The good news is that it is possible to use life insurance for a down payment if you have the right type of policy. Let’s learn more about tapping into your life insurance policy for a down payment.

Having the Right Type of Life Insurance

You need the correct type of policy to use your life insurance policy as a down payment. Unlike term life insurance, which only covers you for a set period, a permanent life insurance policy covers you for your entire life and accumulates cash value over time. The more premiums you pay, the bigger the cash value grows. Once the cash value reaches a large enough balance, you can borrow against that value as you would on a credit card or loan. However, you will pay interest each month (or out of the death benefit) until the debt is repaid.

Some insurance companies also offer universal life insurance, allowing you to contribute extra money to the policy. This builds a larger cash value and more money to borrow from later. The only type of life insurance that you can’t use toward a down payment is term life insurance because it does not have a cash value to borrow from.

How to Take Money Out of Your Life Insurance Policy for a Down Payment

If you have a permanent life insurance policy building cash value, it is relatively easy to use as a down payment on your home. Money can be borrowed from a life insurance policy in three ways:

Loan – A loan is the best choice if you still want to retain your life insurance coverage. The loan will have interest due, accumulating over time, so it is best to repay the loan as soon as possible if you intend to keep the policy for a long time. However, if you make the required premium and interest payments, there is no term limit, so you are not obligated to pay it back in any particular time frame. You should, however, be aware that some lenders will not allow you to borrow funds for your down payment. Typically you must provide the minimum required funds yourself, but you could borrow to increase your down payment.

Withdrawal or Partial Surrender – When you withdraw or partially surrender your life insurance policy, you reduce your death benefit by the amount of cash withdrawn. If you have a high cash value relative to your death benefit, it could impact your policy significantly. It could also result in surrender fees during the first years of your policy. However, a withdrawal is a good option if you don’t mind a lower death benefit but still want to keep some life insurance coverage.

Full Surrender – If you want to access the total value of your life insurance policy and do not need to keep it enforced, you can surrender your policy in full. Your life insurance policy will be gone when you do this, but you can access the total cash value minus any applicable surrender charges.

Benefits of Borrowing from Your Life Insurance Policy for a Down Payment

A life insurance policy with cash value is a very appealing way to help with down payment costs for homebuyers. Here are a few other benefits of tapping into your life insurance policy to cover a down payment:

Lower Interest Rates and Mortgage Payments – When a down payment covers 20 percent of the purchase price (or more) instead of the minimum 5 percent, you may qualify for a lower interest rate, which means lower monthly payments too. You will also not have to purchase mortgage default insurance. All of this means more money in your pocket.

Coverage for Other Costs – Since a permanent life insurance policy can be borrowed against relatively easily, you can also access it for other expenses like the home inspection, renovations, moving costs, or furniture to make your home move-in ready.

Accessible Liquid Assets – Many policyholders use their cash value as a savings account to be accessed in an emergency. If they fall behind on their mortgage payments, they could borrow against the policy and use the funds to get up to date. This safety net gives mortgage lenders more confidence in a potential borrower, resulting in lower interest rates.

Using Life Insurance for Your Down Payment

Using life insurance for a down payment can be a viable option for some homebuyers. Still, it’s essential to carefully consider the implications of borrowing from your cash value before deciding. While life insurance can provide a source of cash to cover a down payment, it’s important to remember that borrowing against your policy can reduce its value and may have tax implications. Additionally, it’s crucial to ensure that you still have enough coverage to protect your loved ones in the event of an unexpected death. Considering all available alternatives and making an informed decision that aligns with your long-term financial goals is essential. Your financial advisor and insurance provider can help determine if this approach is right for you.

Originally published on the RE/MAX Canada Blog.