Cash Value of Life Insurance and Debt-to-Income Ratios
When you’re buying a home, you might need money for a down payment, closing costs (the fees associated with finalizing the mortgage), and reserves (extra money set aside to show you can keep paying your mortgage in tough times). One place you can get this money is from the cash value of a life insurance policy. This is the amount you’d get if you cancel the policy or borrow against it.
However, if you decide to borrow money against your life insurance, the lender (the company giving you the mortgage) needs to think about a few things. They need to see if you have to pay back this loan immediately and how that repayment might affect your ability to afford your monthly mortgage payments. This is important because lenders use a calculation called the debt-to-income ratio to decide if you can afford a mortgage. This ratio compares how much debt you have each month to how much you earn.
Imagine you have a life insurance policy you can borrow against. If you take out a loan against it, but the only penalty for not paying back that loan is losing the policy, the lender won’t count this loan when they calculate your debt-to-income ratio. This is good because it doesn’t make your financial situation look worse than it is.
On the other hand, if borrowing against your life insurance brings up new payment obligations (like regular repayments you must make), these must be considered in your debt-to-income ratio. This could make it harder to qualify for a mortgage. Alternatively, if you have to make repayments, the lender might subtract this amount from your reserves instead.
Documenting Borrower Receipt of Funds
If you’re using the cash value from your life insurance as part of your down payment or to cover closing costs, the lender needs to see proof that you’ve actually received this money. You can show this in two ways: either by providing a copy of the check you got from the insurance company or a statement from the insurance company showing the payout.
If you’re using the cash value from your life insurance as reserves, the lender still needs to see documentation that proves how much cash value is available. However, in this case, you don’t need to actually withdraw the money; you just need to prove it’s there and accessible if needed.
References
For more details, visit Cash Value of Life Insurance of the Fannie Mae Selling Guide.