Life insurance policy loans are a long standing feature of cash value life insurance. And this feature can be a very powerful financial tool at your disposal when used correctly. I would even argue that this feature should be the focus of such books as Bank on Yourself® and Be Your Own Banker®.
Having a grasp of policy loans and the mechanics therein goes much further to make the case for life insurance as a viable financial tool.
Today, I want to walk through a few examples (with math to back them up) that highlight my point about life insurance loans potentially being the superior method of financing purchases.
We Finance Everything we Purchase
I think it was Neslon Nash’s crew that started pointing this one out. In truth, we finance everything we buy, whether it be through interest paid on a loan we acquire to make a purchase, or by the interest we forfeit when we use the money we have in the bank (or elsewhere) to make a purchase in-lieu of using a loan.
Remember, compounding interest either works for you or against you. There's no way to remain neutral.
And because we finance everything that we buy, it is my goal to try and minimize the negative economic impact that this truth has on our lives.
Two Loans with Two Different Outcomes
Let’s use a hypothetical car loan for $35,000. In one circumstance, we’ll use a traditional bank loan to make the purchase. And in the other, we’ll use a life insurance policy loan to make the purchase.
We’ll start with the traditional approach.
After stripping down to your financial underwear to get the lender to approve you for a loan, let’s say you roll out of the dealership in your brand new car while baking in the glory of that new car smell (it’s the glue that holds the carpets down) and grinning at the thought of your new toy.
Your new toy also comes with a book, not the instruction manual, but a 72 page coupon book that you’ll get to look at once every month. You’ll tear out one of the coupons and mail it to the friendly banker who wrote the loan on your shiny new car (unless you opt for EFT).
You managed to get a 5% loan rate on your car, and with a purchase price of $35,000 you get to send a check for $563.67 with each of those coupons.
All told, you’ll pay the friendly bank $5,584.42 in interest for the privilege of driving around in “your” car before you actually own it. Not too bad, but you could do better.
The Life Insurance Loan Option
Instead of coming to the table ready to negotiate price and lending terms, you get to come to the table with cash in hand. No need to answer questions about your finances, and no need to have your credit pulled (those credit checks don’t exactly help your FICO score after all).
You purchase the car for the same amount, and roll out of the dealership, same smile, and same new car smell.
But this time, you have no coupon booklet.
While you’re not under any obligation to send a monthly payment to the insurance company, you choose to because you want to repay the outstanding policy loan. You repay the loan, assuming the same payment schedule from the traditional loan scenario, $563.67.
Because interest is only charged at the end of each policy year, you actually the pay the loan off about three months early and—get this—pay a total of $4,245.68 in interest.
Or let me put that another way–you pay $1,338.74 less in interest than you would have if you borrowed from the bank.
All the while knowing that if you missed a payment, there would be no late payment fee, no calls from collections, and no worries if you have to skip a few months and make up the payments later.
But what if you Could get a Better Deal on the Bank Loan?
Assuming you pay your bills and you have good credit therefore you’d save more money by getting a better loan interest rate (keep telling yourself that). All right, let’s assume 4%.
Then you’ll pay $4,425.91 in interest to that bank, or $180.23 more in interest.
That’s right, 1% less in annual percentage, and you will pay less with the life insurance policy loan. Why? Because the life insurance policy loan is not amortized to ensure that you pay some amount of interest from the very beginning.
The lending industry has been taking advantage of the fact that most people suck at math for years, and we could show you numerous examples of such exploitation, but this one works well enough.
It Doesn’t Stop There
As I’ve already hinted, there’s more to this than just the easily quantified savings. We also have the more intangible considerations like the fact that:
- There is no set repayment schedule so if you don’t have the funds to pay in a given month it’s no big deal. Or even more importantly, you aren’t pressed up against the wall to hit a certain payment date. If you don't get paid or have that commission check come through until later in the month–no worries, you don't have a “due date”. If you forget to send in a payment it’s also no big deal
- The loan is private between you and the life insurer meaning it’s not reported to any credit agency. Since there is no set repayment schedule it would never show up on your credit report for any negatives if you didn’t pay, but more importantly this loan is not included in your debt-to-income ratio, nor does it affect your debt-utilization ratio.
- Processing is quick with no credit worthiness required which means you get money fast without a bunch of prying questions or hoops to jump through with some punch in lending who makes you move money from one account to another just because he has the power…I mean because they need to show the money there instead of somewhere else.
- No down payment contrary to popular belief, down payments have nothing to do with helping you lower your payment and everything to do with psychologically tying you to your loan. Statistically we know people who pony up money to put down on a car, house, etc. are much less likely to walk away and allow repossession/foreclosure/etc.
- Minimal consequences if you can’t repay the loan is backed by the cash surrender value of your policy, which places you in a much strong financial position to begin with. And its because of this fact that there is no repayment schedule and no worries if you don’t pay. If a bad circumstance should arrive, you don’t have to worry about ruining your credit by going into default then paying higher finance fees then having a hard time finding a job then having a hard time finding car insurance then risk being sued then have any professional licenses in jeopardy and the snowball gets bigger and bigger.
This is what the Be Your Own Bank People should Focus on
Instead of some hokum about mythical interest that you pay back to yourself (which is fantasy), we ought to embrace this information, because unlike those other claims all of this information is true—it’s always nice when that’s the case.
And when used correctly these features can place you in a very strong and greatly risk reduced situation. And it’s thinking like this that can get you ahead of the rat race of which everyone so desperately wants out.