When you have a lot of student loan debt, paying it down can feel like a daunting task — especially if you want to pay off your federal student loans early.
Depending on your situation, one option might be using your life insurance policy to pay down your student debt. Here’s what you need to know if you’re hoping to use life insurance to pay off federal loans.
Using life insurance for student loan repayment
Life insurance coverage is designed to help your loved ones and dependents cover expenses after your death. With a life insurance policy, you’ll make a monthly payment, called a premium, to the insurance company.
In return, there’s a death benefit paid out upon your death. This benefit is paid out to your beneficiaries and can be used for various purposes.
Many student loan borrowers like having life insurance for the peace of mind it offers. However, it’s important to note that there’s generally a death discharge for loans if a borrower or student dies.
Death disability discharge for student loans
You don’t usually need to use a life insurance policy to pay off the debt. This is especially true with federal student loans. Some private lenders also offer a death discharge but double-check their terms and conditions to ensure you won’t need a life insurance payout to cover a private student loan balance.
Another possibility is to use the cash value you might accumulate in some types of life insurance to help pay off your student loans early. However, it’s important to note that not all life insurance policies allow this. You might be limited to the type of loan you can pay off and how much cash you can borrow against your policy.
Borrowing against your policy’s cash value
In general, a term life insurance policy won’t qualify for a loan against the cash value. Instead, you might need to look at a whole life insurance policy, or a specific type of policy called an indexed universal life insurance policy or IUL. These types of policies are called permanent life insurance.
To use a life insurance policy toward paying off student loan debt, the policy needs to build cash value over time. An IUL and some other types of whole life insurance invest a portion of your monthly premium payment to grow faster than a regular policy. This helps build cash value.
In doing so, you can borrow against the life insurance policy for cash — or even just take out the cash. Then, repay the loan to the life insurance company with the payments going back into your policy’s cash value reserve. This type of life insurance is often sold to customers as a way of borrowing against themselves.
How to use life insurance to pay student loan debt
To use your policy’s cash value to pay down student loan debt, you need to have built it up. Depending on the life insurance policy, you might need to wait at least 10 years to use your cash value or borrow against your policy, penalty-free. Check the terms of your coverage to see what you can expect.
Next, check your terms and conditions. Some types of life insurance allow you to borrow against the policy’s cash value, providing you with a loan that has no — or very little — interest.
Another possibility is that some life insurance policies, like IUL, let you withdraw the accumulated cash value without penalty. You don’t have to repay the money; you just have to accept that the death benefit will be reduced later.
Before withdrawing, speak with your insurance agent or a knowledgeable financial planner to understand the terms and conditions and verify that you can use the money to pay off student loan debt.
Pros of using life insurance to cover student loans
- Potentially helps you get out of student loan debt faster.
- Avoids pulling funds from your personal emergency fund.
- Can potentially pay a lower interest rate on a cash-value loan than student loans.
Cons of using life insurance to cover student loans
- Whole life insurance policies are more costly than term life insurance policies.
- Could reduce your death benefit for family members who might need it.
- Using your policy’s cash value might mean that you’re struggling financially.
- A down market or other economic event might adversely affect policy’s cash value.
Alternatives to using life insurance to pay student loans
Before you buy life insurance as a way to pay off student loan debt early, consider other possibilities:
- Refinancing. You can refinance your private student loans to a lower rate, get a lower monthly payment and save money on interest. You can also refinance federal student loans, but you lose benefits like income-driven repayment and Public Service Loan Forgiveness (PSLF).
- Loan forgiveness. Check into federal, state and city loan forgiveness programs that can help you get rid of debt faster. If you work with nonprofits, you can qualify for PSLF after about 10 years, which is how much time you’d need to build up a cash reserve in an IUL life insurance policy. Teacher Loan Forgiveness and programs for healthcare workers to receive forgiveness are also possibilities.
- Aggressive debt reduction. If you have the income, you can make a plan to aggressively pay down your debt with a thought-out strategy. You can put that toward your principal and pay off your debt faster if you have extra money. This can also help increase your credit score quickly.
- Balance transfer. It’s also possible to use a balance transfer to repay student debt. If you have a plan, you can move some or all of your balance to a 0% APR credit card and tackle it that way.
- Home Equity Line of Credit. A HELOC can also help you pay off your debt. However, you could be putting your home on the line in this situation, so it might not be the best choice.
Looking for life insurance
Even if you don’t plan to use it to pay down student loans, getting a life insurance policy can make sense. It offers financial protection for your loved ones and peace of mind for you. However, a universal or whole life insurance policy might not be necessary.
Instead, compare different life insurance policies and insurance quotes, including term life insurance.