It is the responsibility of the financial advisor to help clients live the life they want. In our face-to-face interactions, this means we’re listening to them. Yet behind the scenes, it’s imperative to have a deep understanding of what we do and how to do it.
While that should seem like a given, there are still many false perceptions about whole life insurance and what it does (and does not) achieve. One such misconception centers on how a policy loan should work. And as advisors, we must be diligent that we don’t perpetuate these ideas through the language we use.
What is a Policy Loan?
There is more to whole life insurance than policy loans, yet many advisors lean on the policy loan a little too much. This is a natural inclination, given that the strategic use of these loans can help clients leverage opportunities, while the cash value of the policy continues to grow.
However, it’s easy to mislead clients into thinking that policy loans are a magical solution. They’re powerful, yet they have their limits. And it doesn’t serve our life insurance community to plant misleading ideas in our client’s minds.
For example, shifting a loan from a bank or a credit card into a policy loan is not the same as paying off a loan. The loan still exists. It has only moved to a place that provides your client with an advantage—as long as they’ve been taught the value of being their own banker. However, that requires that they understand the importance of making payments so that the policy does not implode.
It’s the same concept as any other loan transfer—when you refinance your home, you still have the debt. You’ve just changed the structure of that debt.
Having the Facts
When you’re doing any calculation, you don’t just need numbers. You need the right numbers. Too often, numbers are left out or added into an equation that changes the context. That’s part of the reason Prosperity Economics Advisors was developed—to create a united front in which whole life insurance agents and advisors deeply understand the industry and the numbers.
One of the leading variables left out of financial equations is the time value of money. For calculations to be accurate, the time value of money is fundamental. In the comparison of two loans, it is not enough to add up the cumulative interest in each loan. That interest must be evaluated over the whole time frame.
Furthermore, the opportunity cost must be considered. What could this money achieve if it were doing something else? In other words, what is the cost of choosing one opportunity over another? A shorter timeframe for a loan may be appealing, and yet that usually signifies a higher payment. A lower payment would provide more monthly freedom and could be better for instilling healthy savings habits. However, you need the BIG picture to decide.
Many people, advisors and clients alike, fixate on interest rates (and subsequently accelerated monthly payments) to their own detriment. There’s a persistent myth that the quicker you pay something off, the more money you’ll save. Yet if you’ve followed Prosperity Economics Advisors for long, you’ll know that we’ve debunked the myth of accelerated payments in numerous ways–cars, mortgages, and more.
The most telling detail of these accelerated monthly payments is that you have to spend significantly more money each year, which reduces your annual cash flow. A higher payment often puts the client in a tighter spot financially and prevents them from establishing healthy savings habits in the present. By the time something is paid off, will your client have the discipline to save?
Don’t fall into the trap of “interest savings” by not fully analyzing a deal, or thinking you can bypass interest with a policy loan. While the cash value of a whole life insurance policy is similar to equity, a loan is still a loan.
Being Your Own Banker
When we talk about interest, it’s also important that we discuss the interest charged by the insurance company. The interest rate on a policy loan may be different, often lower, than the original loan…and yet it still exists. After all, the loan is not paid off, it is simply transferred. Some software doesn’t illustrate the policy interest rates, and yet without it, the comparison is rendered void.
The loan interest from all lenders, including the insurance company, must be considered.
Why Language Matters
The next piece of the puzzle is how we talk about policy loans. When we take a loan, we’re not borrowing from our cash value. We’re borrowing against that value. The insurance company is the lender, and the cash value is collateral for that loan. Otherwise, we’d simply be liquidating the cash value.
If the mission is to educate and empower our clients, we must be sure that the language we use is intentional. This is especially true when we speak about policy loans because the clients must understand that there is still debt. If the policy loan is not paid back, it will be liquidated from the policy. While there are many benefits to a policy loan, magically eliminating another loan is not one of them.
This is also true of our loan “payoff” times. It’s important not to misrepresent the time frame over which the loan is paid. Consider when loan payments are made—the beginning of the month or the end of the month? It could depend. Yet consider that the end-of-year balance is the same as the balance at the beginning of the following year. This has the potential to change a loan analysis, especially when you’re splitting hairs.
Including All the Pieces
Ultimately, when we as advisors are illustrating anything, we must make sure that we’re telling the whole truth, not just a story that tells a segment of the truth. When you’re doing any personal finance or financial advising calculations, you must include all relevant variables and all interest rates. And, you must know how to interpret the numbers correctly.
To sum it up, t is misleading to tell people a life insurance loan is somehow different than a loan with any other financial institution. There is no “magic” with a policy loan, it just looks and sounds that way when you leave out some of the important facts.
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