Don't Borrow Against Your Life Insurance Until You Read This
When to Borrow Against Your Life Insurance—and When Not To
Borrowing against a properly structured whole life insurance policy is often marketed as a powerful financial strategy. But when does it make sense?
Today, we’ll explore the nuances of borrowing against your policy to increase your overall return. In the infinite banking world, it’s common to borrow against your policy to finance purchases for which you would have otherwise used someone else’s money (e.g., bank, financer, lending club, etc).
Whole life insurance policies allow you to borrow against your cash value through a collateralized loan. While your policy grows uninterrupted, you can access liquid funds without withdrawing money directly. Your policy’s compounding growth occurs regardless of whether or not you borrow. This dual benefit is one of the primary reasons policyholders use whole life insurance for financial strategies.
However, borrowing isn’t always beneficial. For instance, buying depreciating assets like a car you can’t otherwise afford with borrowed funds doesn’t generate wealth. The key to success is ensuring that the return on your borrowed funds exceeds the cost of borrowing.
The Math Behind Borrowing: Does It Add Up?
The decision to borrow hinges on this key formula:
ROI = [(Investment Return minus Control Cost) ÷ (Control Cost)] x 100
Here’s how it applies:
- Negative Example: Borrowing at 5% to invest in a CD earning 2% results in a -60% ROI. The control cost exceeds the return, making this a poor decision.
- Positive Example: Borrowing at 5% to invest in an opportunity earning 7% provides a +40% ROI, making this a financially sound choice.
Your cash value will grow regardless, so the focus should always be on whether the funded activity generates returns that exceed borrowing costs. If the numbers don’t add up, it’s better to avoid borrowing.
Borrowing makes financial sense only when the return on your investment is greater than the cost of borrowing.
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Understanding Third-Party Lending vs. Policy Loans
When borrowing against your life insurance policy, you can choose between a policy loan from your carrier or a third-party lender.
Third-party lenders use your life insurance policy as collateral for a loan. Instead of borrowing directly from the insurance carrier, the lender provides the funds while placing a collateral assignment on your policy. If you default, they have a claim on the policy’s cash value and death benefit up to the loan amount. Some things to consider:
- Lower Interest Rates: Third-party lenders can sometimes offer more competitive rates than carriers, thus reducing the cost of borrowing. This highly depends on current interest rates as most third parties lend at prime rate + up to 2%.
- Repayment Terms: Unlike policy loans, third-party loans require structured repayment schedules, which may limit flexibility.
- Loan Application: Loan applications for third parties take longer to set up and require more maintenance year to year, so policy statements must be sent to the lender each year.
Why Choose Third-Party Lending?
The upside? Depending on the market environment, lower borrowing rates could improve your ROI.
The downside? Third-party lending loans come with structured repayment plans, so there is less flexibility than getting a loan directly from the carrier.
Final Thoughts: Be Strategic and Intentional
Borrowing against life insurance can be a powerful financial tool when used wisely. Here’s what to remember:
- Evaluate Returns: Always compare the cost of borrowing to the potential return on your investment.
- Understand the Trade-offs: Borrowing to fund liabilities like cars or vacations may not generate wealth but can contribute to personal satisfaction or intentional living. Acknowledge these trade-offs.
- Explore Options: Consider alternatives like third-party lenders to maximize your ROI.
Whole life insurance is an exceptional asset for storing and growing wealth, offering compounding growth, liquidity, and long-term benefits. However, it’s essential to approach borrowing strategically and base your decisions on math, not what’s trending on social media.
Learn More About The AND Asset
For a deeper dive into using life insurance to build and leverage wealth, explore The AND Asset Vault, a free resource featuring:
- A masterclass on infinite banking.
- The 50-page AND Asset Handbook.
- Podcast insights from leading experts in the field.
Are you looking for even more detailed explanations or deep dives into The And Asset and borrowing against your whole life policy? Watch this!
Contact our team if you have questions about your policy or want to explore how life insurance can align with your financial goals. We’ll help you leverage life insurance to its full potential!
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