On the Borrowing Calculator, just left of the first loan, there is a blank white space where you can place your mouse and it will switch to a hand.  If you click on this, you’ll see the IRR on the entire deal you are looking at on that calculator.

The descriptions of the 4 “loan/withdrawal” source drop downs are as follows:

ACT CASH: removing money from the account via withdrawl

ACT LOAN:  borrowing against the account itself

ALT LOAN:  borrowing against another asset outside of the account

MKT LOAN:  borrowing from the market place, home equity, car dealership etc

This Todd Langford  going  over the Truth Concepts calculator called the borrowing strategy.

What we are going to be showing today is the power of having the client pay themselves, just like they would the bank.  We’ll use a car loan as an example that is borrowed against the savings account and take a look at that versus marketplace loans like you’d receive from a bank and help the client understand the best place to borrow money.

Let’s look at this out over a 30 year time frame, so in illustration period I’ll put in 30.  We won’t be concerned about any existing dollars in the account let’s look at starting from now this individual’s going to save $20,000 a year and in this savings account they can earn 2.5% and that’s going to be taxable earnings we put a tax bracket in here of 30%.  What we can see is if he continues this savings at earnings and tax rate he’s going to end up at the end of 30 years with about $793,999.

 At this point let’s go ahead and add a loan to this.  I’m going to click on Loan/WD 1 and the amount, let’s say a car purchase so $30,000 we’ll purchase it in 3 years so not right away, we’ll purchase one vehicle and we’ll pay this back over 4 years.  Right now it’s showing us the loan but no loan interest because we haven’t put in the interest information. 

The next thing I’m going to do is go to the Loan/WD Payback rate and this is independent of whatever the rates are thats are being charged.  This is the rate that will determine the payment we pay back with.  What I’m going to start with is 8%.  If I do that, it’s going to show me a $9,000 payment on an annual basis that I would pay this loan back.  The Market Loan Rate this will be whatever the going rate is, let’s say for example that right now on car loans the bank is charging 8% and I would use 8%.  The Alternate Loan Rate, this might be a special that is going on like right now General Motors 2.9% rate.  If I put 2.9 in here, it will calculate the payment based on a 2.9% loan charge, and that’s going to be $8,253. 

What we see here is future account value stayed the same because the source of the loan was the Market.  We didn’t touch this account at all, we used the bank or whatever funding source that was available.  What if we were to take advantage of this loan rate like we talked about with General Motors?  If I change this source to the alternate loan it will use the 2.9 rate, since we chose a payback rate of 8%, the calculator will assume that 2.9% went to General Motors in this case, and any excess on that payment is going to go into this savings account and we see it in the Extra Payment Lost or Found column.  So we $1,006 each year for these four years.  The difference is rather than having $793,999 like we would have without this loan strategy, instead what we will have is $800,156.  What happened under this scenario we used a cheaper loan source, but paid it back based on the market rate and we got to reap the benefits of that difference in the payments, we were able to take advantage of the opportunity for a cheaper loan.

We would have another option here.  What if rather than using the 2.9% with General Motors, we chose to fund this ourselves, use this 2.5% asset here.   Whatever the earnings are, in this case the 2.5% if I take money out of here to fund it for myself I give up the ability to earn that 2.5%.  The result is exactly the same as if I had borrowed money at 2.5%.  So let’s see what happens.  If I change my source to Account Cash and rather than $1,009 in additional payment going in each year, we have $1,227 going in each year and the difference is we boosted this future value by about $1,500.  We end up with $801,506.  That’s where the difference is with this particular calculator.  As we create loans, start to finance things using our own assets, and finding the cheapest source for money, as long as we follow through the banking concept of paying our self back and paying ourselves the market rate or more, we’re going to be able to reap the benefit of those cheaper rates. 

We might decide maybe we want some discipline we could pay it back at 12% if I do that then it’s going to put additional dollars in here, it’s going to be $806,520.  This added another $5,000 over this timeframe just because we committed ot making payments at a higher rate.  You’ll notice we didn’t use any info over here in this box the Account Loan Rate.  The reason is with a savings account it does not have the ability to borrow money if we were ot use this account more like a life insurance policy then these items would come into play, Life Insurance policies have loan provision that come with it, and if we have a direct recognition company, then we might have a difference in what the earnings rate was overall on the life insurance on the borrowed side versus the non borrowed side.  So, this would give us the ability to adjust the earnings rate on the borrowed versus the non borrowed. 

Another option here would be to apply this excess payment we have directly to the loan first before going to the savings to see what type of impact that would have.  So I can do that by clicking Apply extra payment to the Loan.  What we see is not a big difference between the two.  Depending on the amount of the loan that will impact whether it’s going to be beneficial to apply the excess payment to the loan or not, and we can use this calculator to determine which is going to be best.

Another option that we have is we chose to do one loan.  Typically if we do a car loan we might do one of those every 4 years, therefore we can change the number of the loans and extend that out.  We could do this over the timeframe total of 6 cars.  It’ll put 6 total loans in here and we can see what type of impact that will have to our bottom line.  If we put 6 loans in here we end up in this case with $857,606 rather than $794,000.  We also have the opportunity to inflate these cars.  We can do 5 additional loans as many times as we want to in the space of whatever our illustration time is.

So what this calculator does in summary is illustrate the principles of banking both borrowing and paying back with varying interest rates, strategies, and money sources.  It enables us to show the client  different scenarios all summarized into one or one simple scenario.  This is a powerful calculator for showing how we can gain control over our own debt and the missing component when people are talking about getting control over their debt, is the part about paying it back. 

At our 2 day truth trainings we spend another hour or more on this calculator showing additional strategies, examples, and ways to use it.  So join us at Truth Concepts.com for one of those trainings, we look forward to seeing you there.

The Truth Concepts Borrowing Strategy Calculator illustrates the principles of banking with varying interest rates strategies and money sources.  Here’s a tip for that calculator:

Toggle off or on the “Future Account Value with NO Loans” by clicking on it. 

Top middle also has an ROR feature that is OFF but can be turned on by clicking in the grey space to the right of the clear button.

Right Click on the 5 “Loan/WD” buttons at the top to re-title them for example: 1. Cars 2. Wedding 3. Child’s Credit Card,  Etc.

How do I figure out if I can get ahead by earning 6% if I have an 8% loan? 

At first glance, the answer is obvious, you don’t get ahead.  However, sometimes we get confused and think that since an account (say at 6%) has an increasing balance while a loan (say at 8%) has a decreasing balance, we might be able to get ahead.  Let’s look at it to see the whole truth of the matter. 

Take a $100,000 account earning 6% over 20 years.  Future Value: $320,713.

We know it earned $220,714 worth of interest.  This is calculated by taking the  $320,714 total and subtracting the $100,000 initial investment.

Now let’s look at a loan for $100,000 at 6%.

We can see that our loan payment is $9430.76 and if we multiply that by 20 years, we get $188,615.20, so we know that we paid $88,615.20 in interest.  So an incorrect deduction would be that it would make financial sense to have 6% earnings while we are carrying 8% debt, but this is only because all of the facts are not presented.  Let’s take a closer look.  The only way to make valid financial conclusions is to have exactly the same cash flows and time periods in each of the comparisons we are trying to make.

Under those guidelines, if we take the $100,000 and pay off the loan at 8%, then take the payments of $9430.76 that we no longer have to make loan payments of and pay them instead to the 6% account, in 20 years, we have $367,731, instead of $320,714 in the earlier example. 

So while it is true that we pay less interest ($88,615.20) than we earn ($220,714), that is only part of the truth.  The whole truth is that cost of money does matter and in the above example, our costs are greater than our gains.  This is the whole truth, even though we earned more interest than we paid out in interest.  There is a $47,017 improvement by paying off the 8% loan with the 6% account and redirecting the freed up payments to the investment.

One critical issue left over is liquidity.  Obviously $100,000 in an account leaves us in a more liquid position initially than $9430.76 being contributed to an account every year.  But eventually the investment account with $9430.76 being added annually will over take the account with $100,000 being contributed up front and will exceed it by $47,017 in the 20^th year.

So if initial liquidity is a concern, then it may be worth giving up some of the $47,017 gain to be in a more liquid position.  However, it is not true that there is a mathematical advantage in having a higher rate of interest on your debt than on your earnings.