June 6, 2025
With the cost of capital escalating due to rising interest rates, commercial loans have become significantly more expensive, creating financial strain for business owners. Fortunately, clients with cash value life insurance policies can leverage these assets as a strategic refinancing tool to alleviate the burden of high interest rates while maintaining financial flexibility.
Addressing the Impact of Rising Rates
The prolonged period of elevated interest rates has left many clients seeking alternatives to reduce their borrowing costs. While refinancing with another lender is an option, prevailing market rates often remain considerably higher than the original loan terms, making conventional refinancing less attractive.
One natural response is paying the loan balance, yet many business owners require liquidity to sustain expansion plans or strategic initiatives. Redirecting capital toward loan repayment can mean sacrificing future growth opportunities, creating a difficult financial tradeoff. However, financial advisors can guide clients toward a more efficient solution, utilizing cash value life insurance policies to replace costly commercial debt with more favorable lending terms.
Life Insurance as a Loan Refinancing Tool
Many clients already own life insurance policies with significant cash value, which may have even been pledged as collateral for their existing commercial loans. Given today’s rate environment, the most effective use of these policies may no longer be as collateral but rather as a direct refinancing mechanism.
To determine whether this strategy is viable, financial advisors should evaluate two key factors:
Comparing Interest Rate
Is the loan interest rate within the life insurance policy more favorable than the client’s current bank loan? Although policy loan rates can vary, the net cost is often lower when accounting for credited interest or dividends on the borrowed amount.
Assessing Policy Performance
Large outstanding loans can negatively impact policy performance, potentially leading to a lapse. A thorough review of long-term policy sustainability is crucial before proceeding.
For some clients, borrowing against their life insurance policy offers a clear advantage over continuing with their bank loan. However, not all policies provide the same loan terms, particularly whole life policies, which could have higher rates.
Optimizing the Strategy with a 1035 Exchange
If an existing policy does not offer a competitive loan structure, financial advisors can explore a 1035 exchange into a new policy that provides:
- Lower loan interest rates
- A sustainable long-term repayment plan
- Potentially enhanced policy performance
By executing a properly structured exchange, clients can transition to a more favorable insurance policy while effectively extinguishing their commercial loan without requiring out-of-pocket payments.
Implementation: Proper Order of Operations
A structured approach is essential for clients assigned their existing life insurance policy as collateral for a commercial loan. Attempting a 1035 exchange while the policy remains encumbered by a collateral assignment is unlikely to be successful. The recommended sequence of actions is as follows:
Initiate a Policy Loan: Take a loan from the existing policy and use the proceeds to pay off the commercial loan. This ensures the bank releases its interest in the policy.
Execute a 1035 Exchange: Once the policy is free from collateral obligations, complete a tax-free 1035 exchange into a new policy with improved loan terms.
Develop a Repayment Plan: Use structured withdrawals, typically up to the cost basis, to manage policy loan payments while preserving policy integrity.
Addressing Loan-to-Value Constraints
Ideally, this refinancing strategy allows for full repayment of the bank loan without requiring additional out-of-pocket expenses. However, if loan-to-value (LTV) limitations or cost basis constraints prevent full repayment, advisors can explore alternative solutions, such as:
- Partial repayment using external assets.
- Utilizing ongoing policy crediting and performance to support long-term loan sustainability.
Regardless of the approach, the primary goal remains: eliminating exposure to today’s elevated commercial loan rates while preserving financial flexibility for future business needs.
Ready To Rescue Your Client’s Loan? Connect With LIFE Brokerage
Financial advisors can transform soaring interest costs into a strategic advantage by tapping cash value life insurance policies as a refinancing tool. A thorough policy review, careful loan structuring, and disciplined repayment planning are essential to deliver lasting benefits and protect long‑term financial goals.
Want a case illustration or policy comparison? Reach out to the LIFE Brokerage team today — we’ll walk you through the details and help you craft the right solution for your clients.
