What do you do when you want to use money from your cash value account? There are several ways to access your cash, the most advantageous of which is usually the policy loan. Let’s review why you might want to take a policy loan, how policy loan interest works, and what to expect.
The Power of a Policy Loan
Yes, one of the most potent ways you can access your cash value is through a loan. The reason it’s so advantageous is that a policy loan allows you to leverage your account in order to use other people’s money (OPM). In this case, you’re using the life insurance company’s money. And because you have cash value to back it up, the insurance company is more than happy to lend you money at any time, for any reason (up to the amount in your account).
There are many reasons this is valuable for you. The first of which is that if you need a large sum of money for something—say a good business opportunity arises—you don’t have to convince the bank to lend you the money. If you have the cash value, you can simply fund it with the insurance company’s money. And if that opportunity provides cash flow, you can use that to pay back the loan.
The second reason this is so powerful is because while the insurance company’s money is hard at work, so is your cash value. Because you’re not withdrawing money, your account balance stays intact. If you have $100k and you borrow against your cash value for $50k, you’ve still got $100k in your account. That means that you still earn interest and dividends on the full value of your cash, rather than a reduced number as you would if you withdrew money. You’ll earn a greater volume of interest this way, so the pool of money you have to leverage just gets better and better.
Another value of the policy loan (although there are certainly many more) is that you can create your own amortization schedule. While a bank loan may require you to make specific monthly payments, you can choose how you repay policy loans. You can make interest-only payments for a few years, then pay the whole thing in a lump sum the next year. Or, you can pay annually for a few years, then switch to monthly. You can even vary your payments from month to month. This gives you a lot of flexibility, which is unheard of in typical banking.
Want to learn more about life insurance loans? Read 7 Things You Need to Know About Life Insurance Loans.
Do Policy Loans Have Interest?
Yes, policy loans have interest. After all, they are loans. So let’s talk about why this isn’t a bad thing.
First and foremost, your life insurance company is a business. And as a policyholder, you stand to gain a lot, so long as the business does well. This is what allows you to have a cash value account as a living benefit, as well as a death benefit that you can rely on. Insurance companies invest very conservatively in things like bonds, and when they make a profit, you see that reflected in your dividends.
And when they loan money, that’s money they’re not investing elsewhere. In order to keep the system running smoothly, that means that they charge you interest. That money is not a wash, though. The interest you pay contributes to company profits, which means by paying loans back, you’re contributing directly to the company’s profits and strength.
Now this does NOT mean that you’re paying yourself interest. However, it does mean that you’re being a good steward of your money and supporting the system that makes your cash value so advantageous. As a customer of the insurance company, you want the insurance company to be successful. It’s in your best interest.
How Does Policy Loan Interest Work?
Policy loan interest is charged up-front, which works out to a daily factor set by the insurance company. For example, you may have a factor of 0.074, while the actual interest rate is a fixed rate of 8%. If you pay your interest up-front, this can make it seem like you’ve got a “discount.” However, what’s really happening is you’re just paying the interest factor on a smaller volume of money. If you stretched out the math, you’d see that over the life of the loan, it doesn’t matter if you pay in advance or in arrears, you’re paying the same amount of interest. There’s no such thing as simple interest.
This is the kind of thing you may see in a status report of your loan. Just remember that between the two numbers they provide, the lower number is a factor of the larger number. The insurance companies have to do this so that if you pay a loan anytime before the end of the year, they can charge you interest accordingly. In the end, any fixed-rate loan that you have will work out so that you’ve paid the rate (the higher number) by the end. You’re not receiving a discount by paying in advance. This can be a difficult topic, though, so if you’re more mathematically minded, check out this post from Truth Concepts that includes calculators.
Shopping Your Interest Rate Options
When you take a policy loan from your company, you can either get a fixed rate or a variable rate, depending on what the company offers. These rates are declared annually, and take effect in the year that you take the loan. So for example, the current fixed rate for some companies right now is 5%, with a factor of 0.046.
So if you took a policy loan with a fixed 5% rate, you’re locking in that rate until the loan is paid off. This can be advantageous if you expect interest rates to increase in the next few years, as insurance companies tend to set their interest rates in relation to the Federal interest rates.
A variable interest rate, on the other hand, can go up or down, also depending on the Federal interest rate. If your insurance company doesn’t offer one, and you want one, there are outside institutions that work with policyholders to finance loans using cash value as collateral.
Another option is going straight to a bank, with or without offering cash value as collateral. If you can get a better interest rate at the bank, and think you can get approved, this is a good option, too. In fact, it may even be to your advantage to start with a bank for financing. Then if things don’t go as expected, you can use a policy loan to supplement. Life insurance opens many doors, you’ve just got to get strategic.
For more information on how to leverage your whole life insurance policy, or to get started on your whole life journey, reach out to us today at email@example.com or book with us.