As the Fed continues to fight inflation, we are now seeing interest rates that have not been seen in decades. Many of us cannot remember a time in our adult lives when the cost of money was so high. Not surprisingly, this is forcing some changes in borrowing money. We started the year with a mortgage rate of about 3%, and now it’s about 7%. Many will say this is a brand new neighborhood for Americans, but older people know we’ve never been here before.
In fact, many have expressed concern about the low interest rates artificially supported by the Fed’s quantitative easing policies after the financial market crash of 2008. We all enjoyed a long period of low interest rates, which made borrowing seem almost inconsequential. Now that those times are over and the cost of borrowing money is likely to be quite high, it’s time to strategize about the cheapest way to borrow money when you need it.
Mortgage interest rates have doubled this year
I mentioned earlier that in early 2022, the average 30-year fixed mortgage (not jumbo) is about 3%. Now it’s 7%. To estimate this in real dollars, let’s look at the monthly payments required for the “average” household in the United States. Fool.com According to the first quarter of this year, the average home price in the United States was $428,700. Suppose you have a down payment of 20%, an interest rate of 3% on a 30-year fixed mortgage, and your monthly mortgage on that home is $1,446. This assumes that you pay property taxes and local utilities, rather than paying them directly.
On the same mortgage, which is currently at 7%, you have to pay $2,284 monthly, which is $838 monthly, $10,056 annually and another $301,680 over the life of the loan.
We have noticed for several years that life insurance loans are an opportunity to buy a home. Using a life insurance loan as an alternative to an existing home equity loan has several advantages, namely a much more flexible repayment schedule, an alternative interest calculation that can save money, and no impact on your debt-to-income ratio if you need to borrow money for other reasons. However, because mortgage rates have been so low, for most people it was still right to choose the traditional way of getting a mortgage. Because the interest they paid on the loan was still lower on a net basis than a life insurance loan. This is no longer true and underscores the basic characteristics of life insurance contracts. Life insurance contracts are much less volatile than most traditional financial instruments.
For example, I have a life insurance policy that uses variable loan rates. This is due to the Moody’s AAA bond index being held out. At the beginning of 2022, the index was 2.79%, but now it’s about 5%. But the interest rate on my life policy is 5%. That means Moody’s wouldn’t budge when interest rates went from 2.79% to 5%.
Also, there are two very important things stipulated in my life insurance policy. First, the interest rate on the loan can only fluctuate once a year. Second, it can only change if the change is more than 0.25%. So my loan rate isn’t going anywhere until the Moody’s index is 5.25%. If that’s the case, it won’t change until I reach my policy anniversary. Pretty cool.
If you took out a loan at 5% from Life Insurance and financed a house like the one mentioned above, you don’t have to pay off the actual loan, but if you used a mortgage calculator to determine a reasonable payment schedule, it would be $1,841. In this case, 100% of the payment would be paid off as principal. This would pay off the loan in 27 years and 10 months. This is because most of the interest paid on the loan in the first few years is interest, and some of it is not written off the life insurance loan in a way that pays off the principal.
Auto loans are also on the rise
As of August of this year, the average autoron interest rate for new cars in the fifth quartile (over 750 points) with the highest credit rating is 8.98%. For used cars, the rate was 9.23%. For those in the second highest quintile (700-749), the average percentage of new cars was 10.94% and used cars was 11.19%. It’s been a long time since people with high or near-star ratings have received financing for cars in the double digits.
Again, these life insurance loans at 5% look very attractive.
In fact, I can look at how life insurance can compare to traditional finance, using my personal story as an example. Because I recently had to buy a new car.
I didn’t really want to tell you what happened to car prices in the last year. But an 11-year-old Volvo station wagon with just under 200,000 miles on the tachometer had used up its last set of tires too soon (it had less than 10,000 miles on it), and I figured I was done trying to figure out the cause.
So off to the dealer’s store to buy a shiny new volvo.
But I did something that was out of character for me, and I financed the purchase. Well, a little bit. My tires were out of whack. That is, the old Volvo had a bad habit of wearing out the tires too fast. Living in Vermont meant that there was no “local” Volvo dealership in close proximity.
I was a little nervous driving my old car there and definitely didn’t want to drive it home. Although I had the money to buy this car, it wasn’t in my current account. I knew I needed time to transfer that money. So, we raised the funds to leave the same day.
The 72-month loan terms were 6.64%, which is just over $56,000. By the way, the price of the car is absurd. I was lucky, I think we had a lower interest rate than the national average.There is nothing special about it, it just is.
The total finance cost, based on the information I got from the dealer, would be $12,278.50 if I extended the loan term. I didn’t. The loan didn’t last a week. But what’s it like to finance it with a life insurance policy loan?
Assuming a 5% interest rate on the loan, the monthly payment should be $800.12. That’s $951.27 less than the $151 needed for a bank-financed loan. The loan is repaid in six years and 11 months. The total interest paid (i.e., the total finance cost) is $9,736.12, so you can save a lot of money compared to bank loans.
Keep in mind that during the period when the loan is outstanding on the life insurance, I still receive guaranteed interest and dividends from my life insurance. In other words, even though I spent some of my insurance money to buy a car, my cash balance is still growing.
These conditions are likely to continue.
High interest rates seem likely to remain an issue for some time. Relatively, rates on life insurance loans are likely to remain low. We warned people about this years ago. The important conclusion here is how life insurance works in relation to vehicles and other financial instruments.
Of course, for several years there has been a slight difference between financing through banks and financing through life insurance. However, if interest rates rise to a level that you think is more realistic, life insurance will be beneficial. It used to be hard for people to see the forest between the trees, but these days it’s getting a lot easier.
Owning life insurance creates additional opportunities, and life insurance contracts tend to make the policyholder financially vulnerable over time. Age has a way of doing that for us.
And finally, as interest rates rise, so do life dividends, making this a much better deal.