Is Premium Financing Right for You?
Asset building can be highly complicated when looking to increase holdings without dipping into your base principal. Borrowing money to finance your acquisitions is often the easiest way. Such financing is prevalent in the stock market through margin accounts. The broker will, in effect, establish a line of credit for a trader to buy stocks, so they do not have to use cash.
This same concept of financing an asset purchase is gaining popularity in the insurance marketplace with the growing practice of premium financing. Essentially, a policyholder agrees with a lender to pay an insurance premium on their behalf. And, as in any loan situation, the policyholder agrees to repay the lender for the cost of the tip, along with interest and fees.
Why would you consider premium financing? It is a technique that allows assets to remain invested that would otherwise be liquidated to pay premiums. On the flip side, it permits funds that would otherwise go to dividend payments to be used for investing. Essentially it allows your money to “work” instead of remaining tied up.
The policy is financed by using its cash value and death benefit as collateral for the loan. If the policy is surrendered, the loan principal is repaid from the cash surrender value. If the policyholder dies, the loan principal is repaid from the death benefit.
However, there are some critical issues before entering into a financing arrangement. These programs are designed for individuals with significant life insurance needs and solid investment portfolios, i.e., reasonable credit risks. Usually, they purchase for reasons such as maintaining liquidity within their estate, transferring wealth, or establishing business continuity.
The second area to examine is why you choose to finance rather than pay the premiums yourself. Financing should be used to help achieve your estate planning objectives of amassing and preserving assets. Life insurance plays a vital role in achieving these objectives but requires a significant financial outlay. While paying premiums can be viewed as a transfer of support rather than an expense, utilizing current assets to pay premiums leaves that money dormant for the policy’s life. With premium financing, a policyholder can take capital that would have been used to pay premiums and invest outside the approach in other high-yield assets.
The third issue to consider is the lender and their contract terms. Purchasing a cash-value life insurance policy is a long-term investment; therefore, picking a lender with proven longevity in the premium finance field is essential. You want to be sure they will be around for the policy’s life. It is equally vital that the lender be a specialist in premium loans. If premium financing is a side-line business, you will probably not be offered the most attractive rates or terms.
To that end, you want to ensure the lender offers a loan with competitive terms and flexibility. Look for a loan that matures upon the insured’s death as opposed to one with a stated call maturity. Call maturities open up the possibility of paying a loan off immediately and not over time, which is more advantageous. Finally, be sure the loan spread is fixed and will not change over the life of the loan. You do not want to be a victim of the instability of interest rates.
