74: Navigating Policy Loan Interest: The Honest Infinite Banker's Guide

[00:00:00] Hello, everyone. This is John Montoya. And this is John Perrings. We are Infinite Banking Authorized Practitioners and Hosts of The Fifth Edition.

[00:00:12] John Montoya: Episode 73, How Policy Loan Interest Works. This episode is courtesy of listener feedback. Weston out in Texas, he has taken the time to listen to all episodes that we've published. So I want to give a shout out to Weston. Thank you very much. He noted that while we did discuss understanding policy loans in episode three, we have yet to really spell out how policy loan interest works.

[00:00:39] So I am going to cover that in today's episode. The first thing that I do want to cover is that there is no free lunch in the universe. Now, whole life insurance, it's based off of math, and I want to point that out because to, to any equation there, there has to [00:01:00] be inputs. And when you take out a loan, whether it's from a traditional bank or even yes from your whole life insurance policy, there is going to be.

[00:01:09] interest calculated. It's not like taking a personal loan let's say from your parents where out of the love that they have for you, they're going to say, okay you can borrow this money and we're not going to charge you any interest. There, there is no free lunch in the universe. And even to that point if you're borrowing money.

[00:01:31] Even temporarily from your parents realize that there's opportunity costs. They are freeing up money that they've put aside for future use in order to make it available to you. And so they are giving up the interest that they would otherwise earn on that money. So if you're thinking about taking a policy loan and you're thinking you know what, I can pay this policy loan back in two months, six months before my policy anniversary.

[00:01:56] Is is up or when it comes back around basically you can have it [00:02:00] paid off within 12 months. I'm going to somehow cheat the system and there's not going to be any policy interest due, right? Not so fast. This is not borrowing from your parents. This is the real world. And just if you take a traditional bank loan when you take a policy loan, there is going to be interest calculated.

[00:02:19] Let's get that. Out of the way and understand that no free lunch in the universe. Now I covered no free lunch. There is going to be interest covered or interest calculated on your policy loan. Doesn't matter if you pay it off before the anniversary year is up. But something more something Additional that you should know about the interest that's calculated, unlike a traditional bank loan, where you're being charged compounding interest daily, when you take a policy loan, it's different.

[00:02:50] It's going to be calculated as simple interest, and it's a simple flat interest. So whether your policy loan is 5 percent or 6 percent in insurance companies they're [00:03:00] all going to be around in the same neighborhood as far as what they charge. It's simple interest. So whatever your loan balance is for the days you have outstanding, it's a simple, in this example, 5%.

[00:03:17] On that loan balance, it does not compound every single day. So real simply, if you take out a $10,000 loan, you don't make any loan repayments at a 5% interest rate, the interest that's going to be calculated on your anniversary date is going to be 5 percent of 10,000, which is $500. If it was daily compounding interest, it'd probably be like.

[00:03:41] Something $567 because there's interest on interest every single day moving forward. So simple interest versus compounding interest. This is way more consumer friendly when you borrow from your policy versus a traditional bank loan. Now, does that mean that. You should [00:04:00] always borrow from your bank loan.

[00:04:01] We've talked about shopping for the money in previous episodes. So I'm not going to spend really any time on that here. But just know that this is more consumer friendly, simple interest versus compounding interest. The life insurance companies, because you are a policy holder, they're putting your interest first, unlike a traditional bank where, they're, the bank is going to want to put themselves in first position, which means that they're going to charge you compounding interest.

[00:04:30] Now, the next question that we typically get when it comes to taking a policy loan Figuring out the monthly loan repayment. And the first thing there is you need to practice being an honest banker. Just because you can take a policy loan doesn't mean that, you should not pay it back. It's absolutely one of the worst things you can do while you're working to take a policy loan and not pay it back.

[00:04:59] So how do you [00:05:00] figure out? What is the best way to make loan repayments? How to calculate that payment. The first thing that I would do outside of shopping for the money to see, where you can get your best financing rate. And let's assume that your policy loan interest rate.

[00:05:18] At 5%, 5 percent or 6% that's going to be the best way to go. If you were shopping for the money and you determined that the best interest rate that you can get from a traditional bank. Is a 7 percent loan and you get the terms from the bank and it's 7 percent and they calculate the interest on a, let's say a five year amortization schedule.

[00:05:42] And that payment comes out to whatever it's going to be. That's really the same at a minimum, that is the same amount. That you should be sending back to your policy in the form of a loan repayment. So if that if that payment to a traditional bank was going to be [00:06:00] 600 a month, every month at a minimum.

[00:06:04] If you're practicing being an honest banker, you should be paying the same amount as a loan repayment to recapitalize your policy. You want to do that because when you recapitalize you're giving yourself the ability to take future loans, right? The uninterrupted compounding interest is going to be working in your favor within the policy, but when you repay the loan and you repay it at the, at.

[00:06:33] Approximately the same rate and schedule that you would be charged on a traditional loan. You're just allowing yourself to. Take to recapitalize and take future loans that will allow you to basically do this in perpetuity. If you're going to be a dishonest banker you're missing the whole point of the strategy.

[00:06:55] Figure out what is the traditional going rate. For the [00:07:00] loan, if you were to finance it through a traditional bank and make sure that matches up with your cash flow. So I think this is the second point here. The cash flow has to match with with what you have going on in your personal life.

[00:07:12] So if you determine that you couldn't afford the bank loan you probably. Honestly, you probably can't afford the policy loan, at least to pay it back over the same schedule. Now, with your whole life policy loan, one of the additional advantages is that you get to determine The frequency of the payment, not only the loan repayment amount, but the frequency.

[00:07:37] So going back to the traditional bank finance, if they've, if they determine the traditional bank determines that your schedule is going to be over, be paid back over five years. And that doesn't work for you. You have the flexibility with your whole life policy to pay it back over six years or seven years.

[00:07:55] And. The, that might fit better with your budget [00:08:00] and you have to determine, okay that, that's going to be doable. You understand that it's going to take. A year or two years longer, depending on what you ultimately decide on as your loan repayment to repay the loan, but it's going to get you back to where you need to be, which is a fully capitalized policy so that you can take your next policy loan.

[00:08:21] Cash flow, it's really important. It's part of the reason why we become our own banker. We want to be in ultimate control of our monthly budget. We want to be in control of our cash flow. So taking a whole life policy loan allows you to do that. Now... Moving on there, there's a question that gets asked where does this interest go?

[00:08:44] You've done your research and you understand that the interest is going to be calculated. It's going to be On your anniversary date, you're going to get an invoice and the insurance company is going to tell you how much interest is going to be added to the policy loan for the [00:09:00] next year.

[00:09:00] So let's assume you didn't pay off the loan in full within 12 months, there is going to be interest calculated and they'll add it. It's called loan recapitalization. They'll add it to your balance for the next year. And that's fine. Because if you're making. Monthly periodic loan repayments. You're gonna, you've basically set a schedule to repay that loan.

[00:09:20] But where does that interest go? It's not going directly to you. And people have this misconception sometimes that when I make a loan repayment, I'm just paying myself back. So let's think about that. When you take a policy loan, who's. If you're borrowing money, are you actually borrowing?

[00:09:36] Are you borrowing your money, your cash value, or are you borrowing money from the life insurance company? The correct answer is you're borrowing money from the life insurance company. So if you're borrowing money. From the life insurance company, they're going to charge you interest. You're going to repay that interest.

[00:09:55] And that interest policy loan interest is going to [00:10:00] ultimately be revenue for the life insurance company. Now, this is really important because we want our life insurance companies to be profitable. And when the life insurance companies do their accounting at the end of the year, part of their profits come from the interest on policy loans.

[00:10:19] And. Ultimately, when the life insurance companies are profitable, they have a surplus profit. Where does that surplus profit go to? It goes back to you and me as policy owners. So while it's not a direct repayment, quote unquote, to yourself, you are indirectly Paying yourself and I say that kind of loosely, but you have to follow the money and where it goes, it's going back to the life insurance company and it'll be part of their surplus profit.

[00:10:55] And that's going to be paid out to you and all the other policyholders in the form of a dividend. [00:11:00] So the more profitable life insurance company is. The better dividend performance they're going to pass on through to you. So this is really a win-win. There, there is no negative to that because look, if you don't want your life insurance company to be profitable, you have the wrong mindset.

[00:11:18] You're partnering with other like-minded people. People who think like yourselves, who are putting their family first. They're putting you're putting yourself first. This is your financial system and you want it to be healthy and vibrant. So you want it to be profitable. So repay your loans, being an honest banker, know that the more profitable life insurance company is the better the dividend performance is going to be, and it's all going to come first full circle.

[00:11:44] Where do the dividends go? We set them up so that they get reinvested back into the policy, increases the cash value, increases the death benefit, and. It just compounds from there. That's the way we want it. There is no negative [00:12:00] aspect to paying interest to a life insurance company, at least to a whole life participating policy.

[00:12:08] Just know that you're doing a good thing there. All right. The next thing I want to move on to, and this is not necessarily directly towards understanding how policy loan interest works, but more of this is a question that I'll get every once in a great while. Should I take a policy loan to.

[00:12:30] Repay a mortgage. Now that's completely up to you. What I would say is if you have a 30 year fixed mortgage, and especially if you're early on into the amortization schedule, let's say you're within the first 20 years of your amortization schedule, the majority of that mortgage is the payment that you're making is going towards.

[00:12:55] servicing the interests. We've all seen it. If you have a mortgage, the every [00:13:00] month you make a mortgage payment, especially early on, the majority is going towards interest. So if you have a thirty year fixed and especially if you were able to lock it in, you know before interest rates rose recently and you have a really comfortable.

[00:13:18] Two and a half, three, 4% four and a half, 5 percent even mortgage rate. Does it really make sense to pay it down even faster using a policy loan? From my perspective, I don't think it does because if there's. One benefit to inflation, it's that you have this fixed rate mortgage that is never going to increase in cost on you for the life of that 30 year fixed mortgage that payment is going to be level.

[00:13:51] Inflation is really going to lower the impact of that mortgage payment every single month. And if [00:14:00] you're also able to get a deduction on the interest that's just a bonus too, but why would you be in a rush to take a policy loan to pay off that fixed rate mortgage even faster when inflation is going to give you the benefit of really lowering the impact of that.

[00:14:21] Monthly mortgage payment on your monthly cashflow over time. And then once you get further along into your mortgage schedule, if you happen to actually be one of those people that lives in their home for a very long time and assuming you're funding your policies too, you're going to.

[00:14:37] Have a ton of cash value where you may decide in the future you just want to pay it off. Okay. I think, that would be worth at least contemplating at a future point, 20 plus years into your mortgage. But before then I'd rather look at my cash value as a, as an opportunity fund something that we've talked about previously.

[00:14:59] I'd [00:15:00] rather, instead of paying off a long term debt, that's fixed. At 2, 3, 4 percent I'd rather take a policy loan and invest at someplace where I'm multiplying my asset base. The mortgage is going to take care of itself. It's already programmed to be paid off. No need to reduce your liquidity.

[00:15:22] To put your bank in a better position because let's face it the faster you pay off your mortgage, it just puts your bank in a better position to repossess your house. If something goes wrong, whereas if you keep your cash value liquid and available for opportunities, and maybe you follow my rule of thumb, always keep 50 percent of your available cash value on hand for life events or.

[00:15:45] Whatever, whatever comes your way you're always going to be in a better position. One of my favorite sayings, you'll never be in a worse position by having access to cash. So to reduce your liquidity, to put your bank in a better position when you've got a fixed rate mortgage, I don't know if that makes a whole lot of [00:16:00] sense.

[00:16:00] It doesn't to me, but to each their own and you'll make your own decisions, but that's my philosophy on it. Last thing I want to cover in this episode is the euphemism of paying yourself extra interest. So hopefully you grasp that There is interest on the loan. You want to be an honest banker.

[00:16:18] But maybe now you're thinking I want to pay off that loan as quickly as possible. So a few additional details. When you take a policy loan, you have that balance. One. Key detail, which I didn't cover, but when you make a loan repayment, 100% of that loan repayment goes directly to the principal loan balance right away.

[00:16:43] So you're really chopping at that loan balance with every monthly loan repayment that you make. And if you set it up on a quarterly schedule, that's fine. But just know that every payment loan repayment that you're making back to your policy, it's [00:17:00] going 100% back to repay the balance of the loan.

[00:17:04] It's not like your traditional bank where the bank sets it up so that you're going to cover the interest first, just like with your mortgage. And then everything else goes towards the principal. Paying yourself extra interest, if you determine that the 7% traditional bank loan would be the rate of what you would repay a traditional bank loan and you determine you're going to stick to that You take it a step further and you think 7% Nelson says, pay yourself extra interest.

[00:17:32] And I've got the cashflow to pay myself 9% interest. What that basically means is you're going to be sending additional amounts to repay that loan balance even faster. That's a good thing. So you'll recapitalize your policy even faster. Meaning that you're going to make that available cash value increase even faster, and you'll be able to take your next loan sooner.

[00:17:59] So [00:18:00] all around, it's a good thing. Now there, there is another method to this too, where if you have additional room in your PUA Rider maybe. You make that 7% payment back to your loan but that extra 2%, you determine whatever, what that amount is. And you send that back to your PUA to maximize your PUA Rider for the year.

[00:18:21] And essentially you're accomplishing the same thing. You're quote unquote, paying yourself extra interest. All that really means is you're saving, right? You're developing this discipline of saving. And that's a really good thing because you're Taking care of your future. And that's the whole reason why we save it's to build capital.

[00:18:41] There's something I heard recently, money is for today. Capital is for tomorrow. If you think about what these whole life policies are you're building capital for tomorrow that you have the use of today, but it's definitely for our future self and for our families, so [00:19:00] paying yourself extra interest.

[00:19:02] It's going to do you a lot of good if you add that to what you're doing with being your own banker. So that really covers all of it. If you have any questions that maybe I didn't quite cover on how policy loan interest works, reach out to Both of us here at The Fifth Edition you can go to TheFifthEdition.com to contact us or even schedule a consultation. We're happy to connect with you and your feedback's really important. This episode wouldn't be possible if it wasn't for listeners like yourself reaching out and say, Hey we listened to all your episodes and there's just one thing that I'm curious about.

[00:19:42] So we appreciate the feedback. We appreciate you listening and as always be safe, be an honest banker, and we'll catch you on the next episode. All right, everyone. Take care.

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