What Is an Automatic Premium Loan?

An automatic premium loan (APL) is an insurance policy provision that allows the insurer to deduct the amount of an outstanding premium from the value of the policy when the premium is due.

Automatic premium loan provisions are most commonly associated with cash value life insurance policies, such as whole life, and allow a policy to continue to be in force rather than lapsing due to nonpayment of the premium.

Understanding Automatic Premium Loans

In order to take an automatic premium loan, you have to have a cash-value life insurance policy, in which every premium you pay adds to the cash value of the policy. Depending on the policy language, life insurance policyholders may be able to take out a loan against the cash value of their policy. This accrued cash value is a value over and above the face value of the policy and can be borrowed against by the policyholder at their discretion.

An automatic premium loan is essentially a loan taken out against the policy and does carry an interest rate. If the policyholder continues to use this method of paying the premium, it is possible that the cash value of the insurance policy will reach zero.

At this point, the policy will lapse because there is nothing left against which to take out a loan. If the policy is canceled with an outstanding loan, the amount of the loan plus any interest is deducted from the cash value of the policy before it is closed.

Special Considerations

Since the accrued value is technically the property of the policyholder, borrowing against the cash value does not require a credit application, loan collateral, or other good faith requirements typically found in loans. The loan is taken out against the cash value of the policy, and the loan balance is deducted from the policy’s cash value if not repaid. The policyholder will owe interest on the loan, just as with a standard loan.

Automatic premium loan provisions help both the insurer and the policyholder: The insurer can continue to automatically collect periodic premiums rather than sending reminders to the policyholder, and the policyholder is able to maintain coverage even when they forget or are unable to send in a check to cover the policy premium.

The policyholder may still choose to pay the premium by the regularly scheduled due date, but if the premium is not paid within a certain number of days after the grace period, such as 60 days, the outstanding premium amount is deducted from the policy’s cash value. This prevents the policy from lapsing. If the automatic premium loan provision is used, the insurer will inform the policyholder of the transaction.

What Is an Amortized Loan?

An amortized loan is a type of loan with scheduled, periodic payments that are applied to both the loan’s principal amount and the interest accrued. An amortized loan payment first pays off the relevant interest expense for the period, after which the remainder of the payment is put toward reducing the principal amount. Common amortized loans include auto loans, home loans, and personal loans from a bank for small projects or debt consolidation.

How an Amortized Loan Works

The interest on an amortized loan is calculated based on the most recent ending balance of the loan; the interest amount owed decreases as payments are made. This is because any payment in excess of the interest amount reduces the principal, which in turn, reduces the balance on which the interest is calculated. As the interest portion of an amortized loan decreases, the principal portion of the payment increases. Therefore, interest and principal have an inverse relationship within the payments over the life of the amortized loan.

An amortized loan is the result of a series of calculations. First, the current balance of the loan is multiplied by the interest rate attributable to the current period to find the interest due for the period. (Annual interest rates may be divided by 12 to find a monthly rate.) Subtracting the interest due for the period from the total monthly payment results in the dollar amount of principal paid in the period.

The amount of principal paid in the period is applied to the outstanding balance of the loan. Therefore, the current balance of the loan, minus the amount of principal paid in the period, results in the new outstanding balance of the loan. This new outstanding balance is used to calculate the interest for the next period.

Amortized Loans vs. Balloon Loans vs. Revolving Debt (Credit Cards)

While amortized loans, balloon loans, and revolving debt–specifically credit cards–are similar, they have important distinctions that consumers should be aware of before signing up for one.

Amortized Loans

Amortized loans are generally paid off over an extended period of time, with equal amounts paid for each payment period. However, there is always the option to pay more, and thus, further reduce the principal owed.

Balloon Loans

Balloon loans typically have a relatively short term, and only a portion of the loan’s principal balance is amortized over that term. At the end of the term, the remaining balance is due as a final repayment, which is generally large (at least double the amount of previous payments).

Revolving Debt (Credit Cards) 

Credit cards are the most well-known type of revolving debt. With revolving debt, you borrow against an established credit limit. As long as you haven’t reached your credit limit, you can keep borrowing. Credit cards are different than amortized loans because they don’t have set payment amounts or a fixed loan amount.

Example of an Amortization Loan Table

The calculations of an amortized loan may be displayed in an amortization table. The table lists relevant balances and dollar amounts for each period. In the example below, each period is a row in the table. The columns include the payment date, principal portion of the payment, interest portion of the payment, total interest paid to date, and ending outstanding balance. The following table excerpt is for the first year of a 30-year mortgage in the amount of $165,000 with an annual interest rate of 4.5%

What Is a 125% Loan?

A 125% loan is a type of leveraged loan, typically a mortgage used to refinance a home, which allows a homeowner to borrow an amount equal to 125% of their property’s appraised value.

For example, if a home is worth $300,000, then a 125% loan would give the borrower access to $375,000 in funds.

How a 125% Loan Works

In financing terminology, a 125% loan has a loan-to-value (LTV) ratio of 125%. The LTV ratio, which compares the size of a loan relative to the appraised value of the property that serves as security, is used by lenders to judge a loan’s default risk. A 125% loan is considered riskier than one with an LTV ratio of less than 100%. In fact, with conventional mortgages, the loan size does not typically exceed 80% of a property’s value.

Therefore, according to the risk-based pricing method used by lenders, a loan with an LTV ratio of 125% will carry a higher interest rate than one with a lower LTV ratio—as much as double, in some instances.

Using a 125% Loan for Refinancing

Homeowners who take out a 125% loan usually do so when refinancing their homes to gain access to more cash than they would have available from their home equity. Their motive might be to use the loan to pay off other debts that carry even higher interest rates, such as credit cards.

But because 125% loans have high interest rates and may also have additional fees, anyone who is considering one should plan to shop around for the best terms they can get.

If your goal is to obtain cash to pay off other debt, and you are unable to qualify for a 125% loan (or you decide that you simply don’t want one), then you might still consider a home equity loan. You won’t get as much cash out of it, but the interest rate is likely to be considerably lower, and you can use it to pay off at least a portion of your high-interest debt. Another option would be to do a cash-out refinance.

Advantages and Disadvantages of 125% Loans

The advantage of a 125% loan is that it can allow a homeowner, especially one who has not accumulated too much home equity or whose property has actually declined in value, to obtain more cash than they otherwise could.

The disadvantage—to borrower and lender alike—is the added risk compared with a smaller loan. The borrower will be on the hook for more debt, and the lender will face added risk in case of a default. If the borrower does default, the lender can foreclose on the property and sell it, but the lender is very unlikely to get all of its money back.

History of 125% Loans

The 125% loans first became popular during the 1990s, in some cases geared toward low-risk borrowers with high credit scores who wanted to borrow more than their available home equity. Along with other factors, 125% loans played a role in the 2007–08 housing crisis. The crash of real estate markets around the country, kicked off by the subprime mortgage meltdown, left many people “underwater”—that is, they owed more money on their mortgage than their home was actually worth.

As home values dropped, some homeowners who wanted to refinance found that they no longer had enough equity in their homes to qualify for a new loan. Moreover, they could not recoup their losses even if they managed to sell the home.

The now-expired federal Home Affordable Refinance Program (HARP) was introduced in March 2009 as a way to offer relief. It allowed homeowners whose homes were underwater, but who were otherwise in good standing and current with their mortgages, to apply for refinancing. Through HARP, homeowners who owed up to 125% of the value of their homes could refinance at lower rates to help them pay off their debts and get on sounder financial footing.

Originally, homeowners who owed more than that percentage could not apply. But eventually, even the 125% LTV ceiling was removed, allowing still more homeowners to apply for HARP loans. After being extended several times, HARP ended in December 2018.