You may be able to find a friendly source to lend you money by using a life insurance policy as collateral for the loan -- much as you would use a house as collateral for a mortgage.

A loan is income tax free to you, the borrower.

If you decide to approach a friend or family member, do so on a business-like basis.

The key word is "like" because while the transaction should be done in a professional manner, your friend is entering into the transaction as a favor to you more than for potential profit.

The other sections of this article cover: 

• The Seven Steps To Take Before Asking For  A Friendly Loan Against A Life Insurance Policy
• Tips About Who To Approach To Lend Money Against A Life Insurance Policy
• How To Put The Transaction On A Business-Like Basis Once Someone Agrees To Make A Loan Based On Your Life Insurance Policy
• What To Include In A Loan Agreement Using A Life Insurance Policy As Collateral

Keep in mind that after you receive the proceeds, it becomes your obligation to keep the policy in force as long as the loan is outstanding.

This process can be pretty depressing. If it is, and discomfort about initiating the topic keeps you from moving forward, speak with your support system -- including a support group and professional help. For tips about dealing with depression, click here.

NOTE:  In order to help other people in a similar situation, please share the form you use, particularly if it was prepared by an attorney. Please black out the names before sending. Please send the copy toSurvivorship A to Z. Indicate if the document was prepared by an attorney, and, if so, who so we can give him or her credit.

Step 1. If you haven't already, review our information on How To Deal With A Financial Crunch.

Perhaps there are alternatives that would decrease the amount of money that you need, or even eliminate the need all together.

Step 2. Determine whether there are alternatives for getting money from a life insurance policy.

First look at the policy to see if there is either a Cash Value or a Living Benefit provision. If there is no provision about a Living Benefit, it doesn't mean you don't have it. It may have been added after the policy was issued, or could be added by a simple call to the insurance company.

If there is a Cash Value or Living Benefit, you can take the money from the insurance company, and still ask a friend for a loan against the remainder of the death benefit.

Step 3. Consider whether you qualify to receive money by selling your life insurance policy as a Viatical Settlement or a Life Settlement and whether you can borrow money from commercial lenders.

To learn more, see Selling Your Life Insurance Policy As A Viatical Settlement or a Life Settlement, Commercial Loans Against A Life Insurance Policy.

Step 4. Contact the life insurance company to find out what is possible.

Let the company know that you are considering borrowing money from a friend and using the policy as collateral to secure the loan.

Ask:

• Is your current beneficiary named "irrevocably" or can you change the person's identity?
• If the beneficiary is named irrevocably:
  • You cannot change to another beneficiary unless the irrevocable beneficiary agrees in writing.
  • If the irrevocable beneficiary doesn't to a change, you can ask him or her to lend you the money. It is in the person's interest to make the loan if he or she believes you will cancel the policy without the loan.
  • Another alternative is ask the irrevocable beneficiary if he or she would agree to turn over to the lender an amount of money equal to the outstanding debt at the time of your death.
• If the designation is not irrevocable, you can change the name at any time. Find out from the insurance company what your alternatives are to protect a friendly lender. For example, is it possible to name a person as beneficiary in a way that tracks an outstanding debt, with the rest of the death benefit payable to someone else? Let's say you have a $100,000 life insurance policy, borrow $10,000 at 6% interest and you don't pay anything back. If at the time of your death, the debt plus interest totals $16,000, can you provide that the amount of the debt then outstanding ($16,000) would be payable to your friendly lender, and the remaining amount ($84,000) would be payable to whoever you designate? If the insurance company will go along with this idea, what proof will be required to show how much debt is outstanding at the time of your death?
• If the insurance company won't go along with this idea, can you designate dollar amounts to go to different beneficiaries? For example, the $100,000 policy, with the $10,000 loan: If you think the debt at the time of your death could be $16,000, make an amount payable to the lender an amount with a cushion - say make the amount $25,000. The rest would be payable to someone else. (You can have a letter agreement with the lender saying that the amount over and above the debt will be payable to whoever you designate. Or you could let the person have the extra money with your thanks.)
• Is it possible to provide that if premiums are not paid on a timely basis, that the insurance company will notify the lender instead of letting the policy lapse? If so, how?

Step 5. Think through how much money you will need.

Of course expenses relating to a health condition can vary greatly, and unexpected expenses can occur.

As an aide to help determine how much you need, look at our information on Financial Planning and complete the interactive charts. You don't have to adjust the amount to reflect taxes because money from a loan is tax free to you. You get to keep all of what you borrow.

Step 6. Think about what rate of interest you should suggest paying. (Interest is the price you pay to borrow money.)

A friend or relative may say that no interest is necessary. However, to have the transaction considered to be a loan, interest is required at least equal to the minimum specified by the IRS. See www.irs.ustreas.gov to find the minimum rate at the time the loan is made.

Step 7. Think through when you will likely be able to repay a loan, including interest.

As you will see, it's important to be open with a friendly lender about whether you will be able to repay the loan, and if so when.

Again, our information on Financial Planning may help. If the result is you are not likely to be able to repay the money, you can ask that the principal and interest be repaid from the death benefits of your life insurance policy.

Consider every person or company you know.

The logical person to ask is the beneficiary of the policy. He or she has the most to lose if you stop paying the premiums and let the policy lapse.

Don't forget your friends, relatives and even your current or former employer. Friends or relatives may feel uncomfortable about purchasing a policy from someone they care about. They may be willing to make a friendly loan using the policy as collateral because the rate of return (interest) is pre-determined and can be pegged to a number that is reasonable to both of you.

It is preferable not to ask someone to borrow money on your behalf on their credit card.

• Interest can pile up quickly on a credit card.
• You may end up hurting the credit rating of someone you care about and who cares about you.

Step 1. Speak with the potential friendly lender and work out an agreement.

Include such things as:

• The amount you're borrowing.
• The interest to be paid.
• When you expect to be able to pay back the loan.

Step 2. Put your agreement in writing.

A written agreement is a professional approach which lets the person know you take the arrangement (and your relationship) seriously. It helps define each of your understandings and expectations. See below, What To Include In A Loan Agreement Using Life Insurance As Collateral.

Think about using an attorney to do the paperwork. Because of the complexity of the arrangement, you are better off using an attorney to draft the appropriate paperwork unless you have a legal background.

Instinct may indicate that this isn't necessary because we're talking about an agreement among friends or family members. Actually, the fact that it is an agreement among friends or family members may be reason enough to have an independent person draft the papers so there is no mis-understanding or feeling that a relationship is being abused.

If you are intent on writing an agreement yourself, there are no do-it-yourself forms of which we're aware. You can start with a collateral loan form available in your local stationary store, or online through such sites as www.uslegalforms.com . The form most likely to work is generally known as a Secured Promissory Note. These forms generally refer to real property, but can be modified for an insurance policy.

Make sure the form was created for use in your state so it is meets the state's requirements for legality.

Step 3. Contact the insurance company to actually make the beneficiary designation you agreed to.

Step 4. Give a copy of the paperwork identifying the beneficiary to your friendly lender.

Step 5. As you make premium payments, forward a copy of the cover note to the lender.

Whether or not this step is required under your agreement, the courtesy will let the lender know you continue to respect your agreement -- and the lender.

At a minimum, include:

A rate of interest and when interest is payable.

For instance, interest at the rate of six percent per year, payable on monthly, quarterly, semi-annually or annually.

When you are supposed to pay back the loan.

For instance:

• The loan could be repayable solely out of the death proceeds of your life insurance policy. It doesn't matter whether your condition is cured. Death and taxes are indeed inevitable at some point.
• The loan could be a "demand" loan -- one that is payable when the lender demands it. (And since the lender is a friend or relative, that may be a long time from now.)
• The loan could be payable at a certain date. If the two of you agree, you can always change the date.
• The loan could be payable in installments. If the loan is payable in installments, include whether each installment is interest only, or part interest and part repayment of principal (the amount you borrow.

Whether there is a penalty if you pay early.

If so, describe the penalty. There should be no need for a penalty since your friend or relative will likely want the money back as soon as practical.

Describe that the insurance policy is collateral to secure repayment of the loan, and the beneficiary designation.

Mention that the lender is named a beneficiary, and that you will not change the designation of beneficiary until the loan including interest is repaid.

Describe the arrangement concerning the beneficiary designation.

If necessary, state that the designation of the lender as beneficiary is irrevocable -- which means you can't change it. If you pay off the loan, the irrevocable amount will still go to the beneficiary so long as you keep the payments going.

Describe your obligation to continue to pay premiums so long as the loan is outstanding, and what happens if you can't pay the premiums.

Include a provision that you will notify the lender well before the due date in case you can't make a premium payment on time.

Give the lender the right to pay the premiums -- and to add any amount he or she pays to the amount of the debt secured by the life insurance policy.

Check the law in your state.

Determine whether there are any modifications necessary to the above or if there are other requirements that relate to content of the agreement and how it should be executed to make it legally binding.