What's the difference between simply taking out a loan and policy loan?

[rousemark]

Thanks for the comments.


I thought that in some of his discussions, either answers to me or answers to others, he had made comments about situations where the total cash value of a policy was earning interest, regardless of whether or not the policy holder had an outstanding loan.

That is correct.

 

[Allen Trent]

Bank loan - Qualify with your credit score, pay interest, once you use up the money you have to pay it back to the bank and never see it again.

Policy loan - No credit check. Probably lower interest rates. And you pay the money back to yourself.

In today's low int rate world, life insurance loans can tend to be higher than bank loans especially if the tax payer can itemize the bank interest as a deduction. Life loans can be at around 7% or more.

Also, you are not paying the interest back to yourself. When you take a life insurance loan, you are not touching your own cash value. The life company is loaning you their own money & they then place themselves on the policy as a collateral assignment so they get paid back what they had loaned to you should you die or surrender. The loan becomes an asset to the life company on its balance sheet. The interest is not always fully paid back to the policy. IE: if charging 7.5% & policy is creating 3.5%, you did actually pay the net 4% to the carrier. Some WL policies also credit a lower dividend rate to the cash value that has a collateral assignment against it.

 

[Allen Trent]

Is the $50K coming from my cash value, policy principle, or the insurer? If it's the insurer, why do I pay me back instead of the insurer?

Disregard anyone that tells you that you are borrowing your own money or paying yourself back. That is flat out wrong. Most agents & books that promote that are not necessarily lying, but more likely ignorant. Carriers have disclosures on their websites about loans to cover their butts when agents make false/ignorant claims about loans.

You are 100% borrowing the carriers funds from their general accounts, not your own cash value. The carrier is merely putting their name on the policy as a collateral assignment just like a bank does on your car title & car insurance & house deed & house insurance. They get paid first if you die before your beneficiary gets paid & they get paid first if you cash out the policy.

All loan payments you make are 100% going to the insurance company & are not directly impacting your base cash value. Depending on the policy type & loan type, the dividend/non guaranteed crediting interest may or may not be the same on the money with a collateral assignment tied to that cash value.

PS-----there can also be some huge unexpected tax problems with loans if they cause your policy to lapse decades down the road. The IRS calculation as to whether you had a gain in the policy doesn't just compare how much did you pay in & how much did you get back out like other annuity & investment products. The IRS calculation counts the entire loan balance(what you took out plus all the compounded interest) in the calculation. This is true whether you took out a loan or if a loan paid your premiums for many years. 40 years out, a $50k loan could compound to $400k or more & easily lapse a policy & cause a $200k or more unexpected tax notice. The books make it seem way easier, but most agents are not around nor is the customer service department reminding you of this during the decades after you made a purchase

Don't take loans from life insurance if you don't have to or if you 100% need the money for a death benefit. pay loan off as soon as possible if you need to take a loan. It may not be the sexiest on a spreadsheet compared to ones showing that you could take 2% loans & invest in stock market at 10% with those borrowed funds. (Arbitrage)

 

[Lloyds of Lubbock]

PS-----there can also be some huge unexpected tax problems with loans if they cause your policy to lapse decades down the road. The IRS calculation as to whether you had a gain in the policy doesn't just compare how much did you pay in & how much did you get back out like other annuity & investment products. The IRS calculation counts the entire loan balance(what you took out plus all the compounded interest) in the calculation.
This is called phantom income. If you took out a loan and never paid it back and the capitalized the interest, it may cause your policy to lapse.
You would be taxed on the loan plus the capitalized interest (of which you never received).
There are so many companies out there giving cash value based loans at very competitive interest rates borrowing from your policy may not be the best way to access money.

 

[rousemark]

PS-----there can also be some huge unexpected tax problems with loans if they cause your policy to lapse decades down the road. The IRS calculation as to whether you had a gain in the policy doesn't just compare how much did you pay in & how much did you get back out like other annuity & investment products. The IRS calculation counts the entire loan balance(what you took out plus all the compounded interest) in the calculation.
This is called phantom income. If you took out a loan and never paid it back and the capitalized the interest, it may cause your policy to lapse.
You would be taxed on the loan plus the capitalized interest (of which you never received).
There are so many companies out there giving cash value based loans at very competitive interest rates borrowing from your policy may not be the best way to access money.

If you can get a better rate at the bank, you can always use the policy cash value as collateral for the loan,

 

[marindependent]

Don't take loans from life insurance if you don't have to or if you 100% need the money for a death benefit.

Sounds like great advice.

 

[david_lewis]

If my life insurance has some cash value in there, I can take out a loan against that policy. What's the difference between this and just simply go out to a local bank and taking a loan?

Most bank (and other loans) are amortizing. You pay interest first, and you make payments on a schedule and terms set by the lender.

Policy loans are collateralized (against the cash value), non-amortizing, interest-only loans where interest typically accrues only on the outstanding principal balance and is billed at the end of the year. Some carriers bill at the beginning of the year, but my experience is those carriers are in the minority.

Loan payments are whatever you want them to be, including $0 (though, unpaid interest will be added to the loan principal if not paid at the end of the year). You can make a set schedule, or just pay interest on the loan.

One of the more significant differences is policy loan repayments go toward the principal during the year, reducing the amount of interest charged/owed at the end of the year.

 

[Allen Trent]

One of the more significant differences is policy loan repayments go toward the principal during the year, reducing the amount of interest charged/owed at the end of the year.

how is this "significantly" different. If I took out a $10,000 loan 5 years ago & used my policy as collateral with insurance company & my loan balance payoff is now about $14,000, how would me making a $3,000 payment today go agains Principal? Are you saying because the carrier would have charged $900 to begin the policy year & if my payment was paid after 3 months of the policy year, I would get credited back for 9 months of interest on the prorated amount I paid back? Regardless, how is this "principal", as the policy loan doesnt ever really show the original loan & cumulative interest like a mortgage might. It merely shows the entire balance, correct?

sorry if this is a dumb question, have a bit of jet lag this morning.

 

[david_lewis]

how is this "significantly" different. If I took out a $10,000 loan 5 years ago & used my policy as collateral with insurance company & my loan balance payoff is now about $14,000, how would me making a $3,000 payment today go agains Principal? Are you saying because the carrier would have charged $900 to begin the policy year & if my payment was paid after 3 months of the policy year, I would get credited back for 9 months of interest on the prorated amount I paid back? Regardless, how is this "principal", as the policy loan doesnt ever really show the original loan & cumulative interest like a mortgage might. It merely shows the entire balance, correct?

sorry if this is a dumb question, have a bit of jet lag this morning.

Some carriers do charge in advance. I *think* Guardian does this, but don't quote me on that.

But a lot of carriers do not. In these cases, policy loan payments are applied against the principal first before the interest payment is made at the end of the year. If you're making regular payments, you're paying down the principle during the year. So, in month 1 after you take the loan, you make a payment (X). Your loan principal is now P-X. And interest only accrues against P. So, with each payment against P, the total interest charge declines during the year. I'm not sure which carriers you use. But, I know for a fact this is how it works at both Mass and Penn. I believe it's the same deal at NYL and NML. My carriers do break down loan principal, loan payoff, accrued interest, etc.

To your other question, yes carriers show it as one loan. It is basically a non-amortized, interest-only LOC. But, the way I do it for myself and my clients is I itemize each loan, and amortize the loan and create something "familiar" with terms and scheduled payments. Something about structure helps clients and they seem appreciative that their policies don't lapse

 

[LostDollar]

Regardless, how is this "principal", as the policy loan doesnt ever really show the original loan & cumulative interest like a mortgage might. It merely shows the entire balance, correct?

That's how my Penn Mutual policy works for anything before the current year.

My current year statement will show the premium due for next year and the current interest due on the loan balance. Any loan related payment I make with the current year invoice will go toward the interest first and then the loan amount. If I make no payment at all, premium or loan, the premium and interest will both be added to the loan amount. (assuming adequate cash value.)

I can make payments during the year to reduce the loan amount. when I get ready to make a final payment, I have to call them to get the payoff amount for loan amount plus final interest due for the current year.