“Should I borrow against my life insurance policy?” Are you ever asked that question? I bet you are.
Recently we conducted an annual review with a client. This client is a transfer client. They moved to our town about 8 years ago. About the same time, their other advisor retired so we were lucky. The conversation was very informative and because of the Truth Concepts calculators, the whole truth was easily demonstrated. Let’s join the conversation partly through the review…..
“I am going to purchase a new car this summer,” Mark said.
“Great idea. How are you planning to finance the purchase,” I inquired. “Remember you finance everything you buy.”
“Yes, thank you for reminding me and yes I remember that,” He replied. “You need to remember that I am my own banker. I plan to take a loan against my policy and finance the car with a policy loan,” He gleamed.
“Do you own a hammer,” I asked.
“What,” He said with a puzzled look on his face. “What does that have to do with financing a car?”
“When there is something to repair around the house do you always grab your hammer to make the repair,” I said ignoring his question for the time being.
“Of course not” He emphatically said. “I use the correct tool for the job at hand.”
“I am relieved to hear you say that,” I said with a smile. “Why are you not doing the same thing when it comes to your financial life?”
“What do you mean,” He asked.
“You told me you were going to finance your car using your whole life policy because you are your own banker,” I said. “That is similar to using your hammer to do all the repairs in your house.”
“Before you get excited about that statement let’s just take a look at a few figures. I am going to use a few calculators from my Truth Concepts software package. This is great software for me to look at a financial question or problem from a non-subjective, whole picture point of view,” I explained. “For starters, if we look at your policy that you purchased from your former advisor, it now has an IRR of about 3.1%. Remember that means that your policy is growing as if it had yielded 3.1% every year since it was first started.”
“I did not know that is what that means,” Mark said. “How does this help me?”
“Let’s assume the car you are going to purchase will cost $30,000. Using a future value calculator we can see what your $30,000 will be worth in 5 years,” I said turning my computer screen so he could see.
“Ok,” He said. “My cash value should be worth $35,023.”
“Well, your $30,000 will grow to that figure. This is an attempt to isolate the $30,000 and just see what it will do, removing additional premiums and dividend fluctuations.” I said.
“Ok so if you take a loan against your $30,000 what is the interest rate you will be paying to the insurance company,” I asked.
When I called yesterday it was 5.0%,” He answered.
Nodding to him I inputted into the payment calculator the date to get the following:
“Based on that information you will have a $566.14 a month payment going to the insurance company,” I said. “Furthermore you will pay a total of $33,968.”
“It so happens that I have been in the market looking for a new car as well,” I admitted. “I went to the credit union over on Maple Street and they are offering a car loan at 2.99%. If you were to use the credit union your payment would be $538.93.”
“And, you will pay a total of $32,336,” I said.
“Why do you want to have a $27 dollar higher car payment a month and pay a total of $1,632 more for your car,” I asked.
Mark sat there for a moment contemplating what I had shown him. Finally, he said, “Because I am my own banker. When I take a loan against my policy I will have $35,023 in cash value when I am done paying for my car.”
“Was that a statement or a question,” I asked Mark.
“Well I am not completely sure,” Mark responded.
“Please allow me to ask you a few questions to help you reason it out,” I said.
“First, if you did not purchase a car or take a loan against your policy how much will your $30,000 be worth in 5 years,” I asked bringing the original Future Value calculator to the top of my screen.
“It will be worth the $35,023 we discussed earlier,” Mark said.
“Second, since your company is a non-direct recognition company, how much will your $30,000 be worth if you do take a loan against your policy cash values,” I asked. “And by the way even if you were with a direct recognition company, we could calculate how much your $30,000 would be worth.”
“It will be worth $35,023 right,” Mark said more asking than stating.
“You are right,” I said. “Do you see it, your cash values are going to grow to the same number regardless if you take a loan or not.”
“So here is my third question, sorry it is the same question I asked before. Why do you want to spend $27 more a month or $1,621 more for your car by taking a loan against your policy versus getting a loan at the credit union,” I asked?
“I don’t,” Mark said.
“Right, you are your own banker. What that actually means is you are in a position of control. You can use your cash values if you want, but you do not have to use them. You need to figure out the cost of capital. It does not matter the source of the capital. Determine the best sources of capital and then if all other factors being equal, use that source,” I explained.
“I guess this is why I need to come to our annual reviews,” Mark said. “I am not an expert, but having someone like you and your Truth Concepts software available to me is well worth my time to meet with you. Thank you.”
“My pleasure,” I said with a smile. “Now let’s talk about………………..”
-Jason Henderson for Truth Concepts