What effect does annual interest on a life insurance loan have?

The correct answer highlights that annual interest on a life insurance loan is added to the loan amount as it accrues. This practice is important for policyholders to understand, as it means that if the interest is not paid, it compounds and increases the total amount owed over time. Consequently, the outstanding loan balance can grow significantly, especially if the policyholder does not manage the loan responsibly.

With a life insurance policy that allows loans against its cash value, the policyholder effectively borrows against their own insurance. While this provides access to funds, it is essential for policyholders to be aware that as interest accumulates, it adds to the principal amount of the loan, affecting the policy's eventual payouts or death benefits if the loan is still outstanding at the time of the policyholder's death. Therefore, understanding the implications of interest on such loans is crucial for financial planning and policy management.