Policy Loans: In Advance vs In Arrears

Sometimes, life insurance companies differentiate how interest is applied to policy loans by using the terms “in Advance” or “in Arrears.” This has led to the common question: is there a difference in the rate and how the company applies it to your loan balance?

The answer is a resounding NO.

In Advance vs In Arrears

“In advance” refers to what the insurance calls a “rate” for making your loan payments upfront. This confuses the issue because people then believe it's a completely separate interest rate when it's not. This “rate” should really be called a factor, because it's only used to determine the up-front payment.

A true rate has to be “in Arrears,” and the “in Arrears” rate applies no matter where you make the loan payment. The reason they seem different is that when you make a loan payment in advance, there's a lower amount to apply the interest rate to. Yet insurance companies state the in advance/in arrears rates in a way that gives a false impression that you're paying at a lower rate by paying in advance.

To reiterate: the “in Arrears” rate is the only rate that you get charged and is charged on any outstanding balance. This is true regardless of whether you make the payment “in Advance” or “in Arrears.”

In Advance vs In Arrears in Loan Analysis

If you're still skeptical, let's look at an authentic example in the Loan Analysis calculator. This company, at one time, published an “in Arrears” of 8% and “in Advance” of 7.407%. Let's say the loan is $10,000 and the owner of the policy wishes to pay it annually over 5 years. We'll also set the payments to the beginning of the loan period.

Once you input these numbers, you'll get the numbers below. Namely, you'll see an Annual Payment of $2,319.04. Pay attention to that.

Using Loan Analysis to compare in advance vs. in arrears loan rate.

Now, let's look at what an “in Advance” payment might look like. If you multiply the “in Advance” “rate” by the $10,000 loan, you get $9,259.26. This represents the remaining loan balance after paying the first payment in Advance. Then, set the payment to End of Period.

What you'll see is that the annual payment is exactly the same: $2,319.04. What's really tricky, though, is how the insurance company represents the “rate” for paying in advance. They suggest that it's 7.407% and on a $10,000 loan it looks correct, considering the first interest charge is $740.74. However, remember that the interest is not being charged on $10,000 if you pay in advance. It's being charged on the remaining loan balance of $9,259.26. If you multiply THAT number by the “in Arrears” actual interest rate, you get $740.74.

If you're still skeptical, just look: the cumulative cost is the exact same for both loans. And that's not even including the $740.74 payment you made in advance.

As noted, this is confusing because of the way insurance companies have incorrectly chosen to call the “in Advance” number a “rate.” There is no advantage or magic to paying your loan in advance, even though it may seem that way. All you're really doing is reducing the loan, so you have a lower balance to accrue interest on.

If you want to get really technical, you're also getting a smaller loan. When you pay in advance, you're really only borrowing the amount you want, minus the first payment. To get the full impact of a policy loan, don't bother paying in advance.

To learn more about how to use the Loan Analysis calculator and the concepts it can illustrate, attend a Truth Training. You'll get prime training on every Truth Concepts calculator, as well as an idea of the concepts you can demonstrate with our suite of calculators.