Can't I Bank with a Different Asset

Can’t I “Bank” with a Different Asset?

I have spoken to a lot of people about financing the various things in their lives using a properly-designed whole life insurance policy from a mutual insurer. I recommend using these policies like your own bank, but sometimes I hear people say they can just “bank” with a different asset.

Confident that they have fully grasped the concept after a brief discussion and eager to show that they do not need my advice, they say something like: “Oh, I get it. Well, I can do the same thing right now with the equity in my house, so I don’t need another way to accomplish the same thing! I can see how this might help someone who doesn’t own their home, though.”

Now, I don’t blame anyone for saying this. It’s not like anyone has taught them the mechanics of whole life insurance. If they have heard anything about it at all, it’s probably only that “whole life is a bad investment.” (It shouldn’t be thought of as an “investment” at all, but used properly it can be a life-changing platform for your wealth.)

How a Home Equity Loan Works

Let’s start with the home equity loan that our objector has in mind, since that is the more commonly understood instrument. (These are closely related to, but not the same as, home equity lines of credit. You may have seen the shorthand term, HELOC.)

Jack and Jill have a mortgage balance of $300,000. Their home is currently worth about $500,000. They think to themselves, “Why don’t we use some of this home value to buy a second car? We can pay cash for the car, and then just pay off the home equity loan! We will get a much better interest rate this way.”

They go to the bank that holds their mortgage and ask for a home equity loan of $50,000. Jill wants a new Lexus!

It’s been several years since they started the mortgage, so the bank needs to ask all kinds of questions again. They do a credit check, verify income, require all kinds of forms and signatures and documentation. They make it clear that the collateral on this loan is the house itself. That means that if the payments stop coming in, Jack and Jill could have their home seized by the bank!

Jack and Jill are relieved when they finally satisfy all the bank’s demands. Weeks later, they receive the money for the car. Jack’s income is great, and it’s only a few hundred more dollars going out the door each month. No problems in sight!

Home Equity Loan Review

Pros:

  • Relatively fast access to cash, pending loan approval.
  • Interest rate can be attractive, depending on your credit score and other factors.

Cons:

  • Putting your house on the line.
  • The bank sets the interest rate.
  • The amount of money available to lend depends on the market value of the house.
  • May not be available at all (it’s up to the bank!)
  • Must explain to the bank what the money is for.
  • Must make payments back on the schedule set by the bank.
  • For a $50,000 loan at 5% interest for 7 years, that’s a balance of $59,362.42. The only want to reduce that is to make additional, early payments. (Calculated at Bankrate, here! Feel free to run your own numbers.)
  • If Jack dies unexpectedly, Jill still owes the money.

How a Whole Life Policy Loan Works

Now let’s look at a policy loan from a properly-designed whole life policy.

Bill and Bonnie have been paying their premiums faithfully for several years. Their situation is almost exactly like Jack and Jill’s, but they have been putting lots of money into a whole life policy on Bill’s life. Like Jack, Bill is the primary breadwinner and making a solid income.

Bill’s policy currently has a death benefit of $500,000. They have $100,000 of cash value in the policy. Bonnie also wants a new Lexus, so they agree to use their cash value for this purpose.

Bill logs into his account online, types in “$50,000,” and 1-2 days later the funds are in their checking account.

They decide they would like to pay the loan back in monthly installments, but know that if they miss payments, it’s fine.

Whole Life Policy Loan Review

Pros:

  • Immediate access to the money, no questions asked.
  • As the loan is paid off, their available cash value in the policy goes back up. (In fact, depending on the insurer, it may grow even while the loan is outstanding!)
  • Low interest rate that is not based on your credit score. (Though I would encourage you to put in more money than you have to!)
  • Guaranteed loan approval.
  • Life insurance company can’t take your house.
  • If Bill dies unexpectedly, Bonnie receives a check! (The death benefit minus the loan balance.)
  • Interest is added the longer the loan stays out, since no terms are set up front. Where Jack and Jill are “locked in” to a 7 year repayment that starts out at $59,362.42, Bill and Bonnie start with a loan balance of roughly $50,000, and the balance only increases if they repay slower than the interest accrues.
  • Repayment is “when you want to.” Can pay it off immediately, make several small payments, or wait 20+ years to pay anything at all. You are in control of this!

Cons:

  • Must be set up in advance.
  • Requires discipline to use properly. You must put money in to have cash value to loan!

So, reader, you tell me: Can you bank with a different asset?

This Sounds Too Good to Be True!

That’s exactly what I thought when I learned about this idea. It took me almost 2 years to actually get started with a policy of my own. It sounded impossible to have lending terms that flexible.

Why is a life insurance company willing to do this?

Simple: They don’t have to do anything extra to recover the collateral.

The Bank’s Situation

Let’s look back at the bank that has extended both a mortgage (with a balance of $300,000) and a home equity loan (with a balance of $59,362.42) to Jack and Jill. If the couple stops making payments for any reason, the bank can (and will) eventually repossess the house and sell it to get the money. After all, they still have over $359,000 in expected payments to recover!

The process of foreclosure and selling the home is expensive, time consuming, and not what the bank wants to be spending resources on. So, they are fairly careful about who gets these loans, and what terms they are offering.

The Life Insurance Company’s Situation

The life insurance company has none of these concerns. The “house” is the whole life policy itself. If Bill and Bonnie stop making premium payments, the life insurance company is no longer on the hook to pay the death benefit! Rather than send the account to collections, they will send you a check for your current cash value if you surrender your policy or live to the end of the contract. (Typically age 100 or 121.)

Find me any situation where you can stop paying a bank for a debt and they send you a check!

So, to say it a slightly different way: The collateral for your policy loan is the policy itself.

When you die, the life insurance company will do this math problem: Death Benefit – Outstanding Policy Loan Balances = Payment to Beneficiary.

That’s it. No eviction, no selling a house, no extra expense.

Now, to be clear: There are a multitude of reasons you should make your premium payments. (And the life insurance company provides more flexibility to ensure your policy stays in force!) But even in a truly desperate situation, it should be clear which asset is better to use for your financing needs. You may also be interested to learn how banks handle the money you deposit with them. There are many reasons not to bank with a different asset.

When you are ready to learn more, I am here to help!

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