Question Regarding Policy Loans

aureo11

New Member
17
I've read multiple places about how one of the nice things about policy loans is that the insurer charges simple interest. I wanted to make sure my understanding regarding the simple interest charged by the insurer vs the compounding nature of credited interest on the cash value is correct. I’m going to throw out an example and would appreciate comments.
For the example I’m going to assume no new premium payments year after year to keep the numbers simple.

Account Cash Value: $10,000
Dividend rate: 4.75%
Loan rate: 5%

Say I take a loan for most of CV, $9,500. My understanding is that interest is charged up front, so $475 will be added to the CV taken, leaving a CV of $25.

At the end of the year, I receive my dividend of $475, so my CV goes to $10,000+$475-$9,500-$475= $500

At the start of year two, they charge the $475 interest for the loan again (this is where the simple interest kicks in, since technically I owe them $9500+475 from the first year), leaving CV of $25.

At the end of the year, I receive a higher dividend of $498 ($10,475*4.75%), so my CV goes to $10,475+$498-$9,500-$475-475= $523

This shows how the credited dividend is being compounded, but the interest charged is not. The first year the interest gained and interest owed were the same, but the next year interest gained was higher already.

Three questions:
1. Is my example here correct?
2. What happens if I took out the $9,500 loan and repaid it in 6 months, would half the interest charged of $475 be re-credited to me?
3. What if I made 5 monthly payments of $1,900 ($9500 total)? What would I owe in interest?

Thanks in advance for the responses.
 
You may be splitting hairs that don't need to be split. If you're telling people that loan interest is "simple", I would stop saying that. Here's what happens...

When you do a policy loan, you are borrowing from the insurance company, using your cash value as collateral. The company charges you interest for the use of their money, and your cash values continue to grow with no regard to whether there's a policy loan or not. Likewise, your dividend will be credited, loan or no loan. The dividend may be reduced if there's an outstanding loan (direct recognition).

If you pay at least the loan interest each year (to the insurance company, not to your cash value), your loan balance for the next year will be the same, and your loan interest will also be the same.

If you don't pay the loan interest when due, it will be added to the principle balance of the loan, and you will then owe interest on the principle PLUS interest on last year's unpaid interest... in other words... COMPOUND INTEREST.

I wouldn't get any cuter with an explanation than that. Going deeper with an explanation of how policy loans work will not help you place more business.
 
I've read multiple places about how one of the nice things about policy loans is that the insurer charges simple interest. I wanted to make sure my understanding regarding the simple interest charged by the insurer vs the compounding nature of credited interest on the cash value is correct. I’m going to throw out an example and would appreciate comments.
For the example I’m going to assume no new premium payments year after year to keep the numbers simple.

Account Cash Value: $10,000
Dividend rate: 4.75%
Loan rate: 5%

Say I take a loan for most of CV, $9,500. My understanding is that interest is charged up front, so $475 will be added to the CV taken, leaving a CV of $25.

At the end of the year, I receive my dividend of $475, so my CV goes to $10,000+$475-$9,500-$475= $500

At the start of year two, they charge the $475 interest for the loan again (this is where the simple interest kicks in, since technically I owe them $9500+475 from the first year), leaving CV of $25.

At the end of the year, I receive a higher dividend of $498 ($10,475*4.75%), so my CV goes to $10,475+$498-$9,500-$475-475= $523

This shows how the credited dividend is being compounded, but the interest charged is not. The first year the interest gained and interest owed were the same, but the next year interest gained was higher already.

Three questions:
1. Is my example here correct?
2. What happens if I took out the $9,500 loan and repaid it in 6 months, would half the interest charged of $475 be re-credited to me?
3. What if I made 5 monthly payments of $1,900 ($9500 total)? What would I owe in interest?

Thanks in advance for the responses.

Larry is spot on.

In addition, the answers to your questions are that -

1. you are on the right track, but dividend rates don't exactly equal to an exact dollar figure (there is a complex formula that determines the actual amount of cash credited to the policy each year). No way you can predict an exact $ amount, so don't try. So for example, just because you have $10k in cash value and a 5% dividend rate, that doesn't neccessarily equal $500 credited. I wish it was that simple. LOL

2 & 3. You rec'v a reduction in interest owed with each payment, "x" amount of the interest paid credited back to you with each payment you make. If you paid it off early, you'll be charged less interest than the whole years rate - based on when you paid it off. You are paying interest on a decreasing balance. So paid off in 6 mos probably 1/3 the interest or less.

I've had some clients take loans and repay them in just a couple months, not much interest charge is accrued at all.
 
Thanks for the responses Larry and Pfg1.


Larry I understand what you are saying regarding not placing more business because of this. I want to understand it as well as possible myself because I'm a math type that enjoys learning as much as possible about minutia such as this. I've simply seen the simple interest noted in multiple places and it didn't make sense to me that it wouldn't compound if you didn't pay off the loan. Pfg1 confirmed my thoughts on what happens.
 
I'm not a whole life expert but do not confuse dividends with internal rates of return. I may be wrong but are not dividends based of of the death benefit not cash va lue
 
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