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.
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.
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.
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.
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.
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:
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.
Brandon launched the Insurance Pro Blog in July of 2011 as a project to de-mystify the life insurance industry. Brandon was born in Northern New England, and he currently calls VT home. He attended Syracuse University and graduated with a triple major in Economics, Public Administration, and Political Science.