How does a policy loan work vs paying cash for purchases?
Much of the Infinite Banking Concept revolves around the fact that we can take a policy loan against the cash value inside of our life insurance policy. Although this may seem confusing, let’s look at it in the most simplistic way we can.
Let’s try to understand why taking a policy loan is more effective than paying cash for major purchases–the most often used scenario being a car.
Paying Cash for a Car
Here is what happens when we pay cash for a car.
Let’s take a 35 year old, call him Abe, who is going to buy 5 cars for the rest of his life.
Abe saves $5,000 a year, every year, for 5 years, and then buys a car for $25,000. Then he repeats the cycle.
At the end of Abe’s last buying cycle, how much money does he have? He has zero.
He just spent the last $25,000 on his final car.
Abe has lost the entire opportunity cost, or value of his money, that he could have had if he was earning interest on this $25,000 over his lifetime.
Let’s look at what would have happened if Abe had used an Infinite Banking policy.
Using Infinite Banking Policy Loans
Using an Infinite Banking policy to buy cars nets us the gains that we normally lose when we pay cash for something. This is because we allow our high cash value life insurance policy to grow, with compound interest, while we continue to buy and save up for our vehicle purchases.
Let’s break this scenario down a bit more and see what would happen if Abe had used an Infinite Banking policy.
Years 1 to 5 — Building
The first 5 years are building. In this scenario, Abe would be putting his money into his life insurance policy and building the cash value. If done properly, in most cases, we would be able to borrow $25,000 from our life insurance policy in year 5.
Year 10 – Starting to Compound
In year 10, Abe would now have $30,929 in his Infinite Banking policy. However, we have to remember, he is also paying interest on the policy loan. Let’s use 5% as a simple example.
Abe would have paid $3,306 in interest on his policy loan.
At year 15 Abe would have $41,803 in his policy and would have paid a total of $6,612 in interest.
Year 20 would leave Abe with $56,225 in his policy and he would have paid $9,918 in interest.
$75,202 in his policy and $13,224 in interest paid.
Year 30 – End
At the end of this scenario Abe would have $99,893 in is policy and he would have paid a total of $16,530 in interest.
Using our Infinite Banking policy costs us a little more than paying cash–of course. However, we are letting our money grow with compound interest. This is significant over our lifetime.
For someone like Abe, this was the difference between having nothing for retirement, or having anywhere from $75,000 to $100,000 more in our account.
Paying cash is not as effective as letting our money continue to grow.
Now think is Abe could have gotten a loan for his car at 2% and still let his money compound at 5% or more. The difference could have been even better.
The reality is, compound interest is so powerful. If we can put our money to work over the long-term, it will pay off.