All men are created equal….All loans are not.
Do you like looking at your payment breakdown on a loan and seeing how front-loaded the interest is?
Let me introduce you to a way of thinking and evaluating loan options by looking at the interest volume.
When you go to the Doctors office to get a shot, are you concerned with the rate at which the medicine is injected into you or the volume of medicine that is injected into you?
Take a mortgage, for example. The first five years are front-loaded with interest. Even though the interest rate may be 3, 4, or 5%, the interest volume in the first five years is north of 50%! This means the majority of your money went towards Interest! Then, most people refinance and start this process over again. Banks are no idiots; they understand this.
An example is on a 400k loan at 5% interest amortized over 30 years, the monthly payment is $2,039. Over the next five years, you will pay $122,340 in payments. Of that $122,340…..$91,346 was interest! That means that 75% of the money you paid on the loan just went towards interest. So much for a 5% Interest when you just paid 75% In interest Volume! That means .75 cents out of every dollar you used to pay your mortgage the last 5 years went straight to the bank in interest!
Imagine if that amount could have went right towards principal!
(yes, I understand there can be value to a loan if leveraged properly for an asset that produces more revenue than it costs, this is just an example to explain volume vs rate. Understand the principal behind this as it applies to all loans)
Policy loans from insurance are very unique and powerful if used correctly. Interest on policy loans accrue daily and compound annually. Reread that again. Think of a credit card. Credit cards also accrue interest daily except that interest compounds monthly and is added to the balance the following month.
When you make a payment on a normal loan, think about an auto loan for example, a portion of that payment pays towards your interest due and a portion towards principal. Imagine if your whole payment went directly towards principal!
Wouldn’t you be able to pay the principal down quicker? Wouldn’t less interest accrue because the balance is decreasing? Yes and yes!
Comparing interest rates is not always an apples to apples comparison.
Lets look at an example where interest rate is different than interest volume.
Lets say you take a policy loan for $50,000 at 6%. It could be to buy a car, an asset, invest into a deal, whatever the case is lets just use $50,000 for the example loan. If you make no payments on it, and pay it off at month 12 you would owe back $53,000. ($50,000 of principal, $3,000 of interest. Here is an example where the interest rate = the volume of interest….6%.
Now lets say you take another $50,000 loan at 6% but this time you get a windfall halfway through the year and decide to make a payment at month 6th for half ($25,000) and month 12 pay the remainder. What would this do to your interest volume?
Well in the first 6 months, you would accrue $1,498 of interest, and on the second half of the year you would accrue $750 of interest. Remember on policy loans Interest is accrued daily, and compounded annually. Total Interest on this loan comes to $2,248 which is 4.4% of interest volume illustrated in percentage.
Here you can see interest volume (4.4%) did NOT equal the interest rate (6%).
Heres another example, lets say you make payments monthly of $4,300 to get it paid off within 12 months. Eac month you’re going to be paying down principal and you know, interest is applied daily so as principal decreases, the amount of interest accruing is also decreasing. At month 12, you would have paid $1,559 of interest over the last 12 months. That comes to 3.1% of interest volume!
Interest Volume was only 3.1% on a 6% interest rate loan!
All men are created different, all loans are not!
Loans calculate interest differently. Comparing a 4% loan from a commercial bank to an insurance policy loan that has a 6% rate is comparing apples to oranges. Interest and payments are applied differently.
Heres the best part- remember with a policy loan your cash value continues to grow. So in that last example, if you paid $1,559 of interest and your cash value accrued 5% ($2,500) you’re actually a head of the game! You earned $2,500 and paid $1,559 and if that $50,000 was invested into an asset you also had the growth of the asset!
This is why policy loans are so powerful! Do this over and over again with all your financing needs. Teach this to your children and you can change the legacy of your family.
Disclaimer and Waiver
Michiel Laubscher & Laubscher Wealth Management LLC is not an investment advisor and is not licensed to sell securities. None of the information provided is intended as investment, tax, accounting, or legal advice, as an offer or solicitation of an offer to buy or sell, or as an endorsement, of any company, security, fund, or other offerings. The information should not be relied upon for purposes of transacting securities or other investments. Your use of the information contained herein is at your own risk. The content is provided ‘as is’ and without warranties, either expressed or implied. Michiel Laubscher & Laubscher Wealth Management LLC does not promise or guarantee any income or specific result from using the information contained herein and is not liable for any loss or damage caused by your reliance on the information contained herein. Always seek the advice of professionals, as appropriate, regarding the evaluation of any specific information, opinion, or other content.
