The Infinite Banking Concept is a thought process that teaches one how to take control of the banking function in their life. Anyone who is an IBC authorized practitioner will show you how to implement this with dividend paying whole life insurance.
You can perform the banking function with other financial vehicles though, so why don’t we use something else?
This will be far from an all-encompassing list, but I want to walk through three different financial vehicles in this blog.
Stocks, Mutual funds, and Exchange traded funds (securities)
To use these vehicles, you would use what is known as a margin loan with your brokerage. You fill out some paperwork, sign the agreement, and can generally borrow 50% of the equity you have in securities (not all securities count toward equity you can leverage). 50% of your equity would be what’s called your initial margin. Your initial margin is what you can borrow up to. Then, typically brokerages lower your maintenance requirement, that may be to a number like 30%, to account for some potential downfall in the market. Let’s look at an example.
I’ll pretend you have $100,000 in securities, and all these securities count toward equity you can leverage, for simplicity. Your initial margin would be $50,000. There aren’t a lot of restrictions on what this money can be used for, but we’ll say you use it for something other than investing back in more stocks, like a car purchase. Again, trying to keep this simple.
You have borrowed out $50,000 now, this is all you can borrow against. Your brokerage could lower your maintenance requirement to 30%, and we’ll say they have. Now, remember your $100,000 in securities is the collateral for your loan, and we’ll say they have now dropped in value to $60,000. If you take $60,000 - $50,000 = $10,000, you only have $10,000 left in equity ($60,000 security value - $50,000 outstanding loan). I established you have a 30% maintenance requirement (think equity here), and 30% of $60,000 is $18,000. In this case you would get what’s known as a margin call for $8,000 ($10,000 remaining equity + $8,000 cash = $18,000 maintenance requirement). This brings you back up to your 30% maintenance requirement (equity).
This was a VERY simplistic example. I did not account for loan interest. This is only meant to show you a potential downfall of using a margin loan if the market goes down. There are SEC and FINRA regulations involved with margin loans, and individual brokerages can change them to something more conservative based on their own policy. I don’t want to walk through all of these regulations because it is not the objective of this blog.
This is only 1 example and I did not walk through every potential outcome. If you are interested in this strategy, DO YOUR RESEARCH AND EDUCATE YOURSELF ON THE ADVANTAGES AND DISADVANTAGES. Don’t use this as advice.
- Potential upside of market
- Using leverage to buy stocks COULD amplify potential gains
- Few restrictions on how you use loaned money
- Typically will not have a strict payback schedule
- Market drops
- Using leverage to buy stocks WILL amplify losses
- Must have cash available for margin call
- A call is due immediately, you may only have 2-5 days to deposit cash.
- If you don’t deposit cash, you could potentially have your entire account liquidated without notice.
- A liquidation doesn’t mean your loan balance will be paid in full either.
- Maintenance requirements can change.
- Lack of CONTROL.
- Only have access to 50% of equity.
- Requires you to watch your account carefully in a downward moving market
- A downward moving market and an outstanding loan balance create a compounding problem against you and your money
Home Equity Line of Credit
Often this is considered a second mortgage, but functionality resembles that of a credit card. Typically, your available credit is 85% of your home’s appraisal value, minus your existing mortgage. So, if you have a $200,000 home and owe $50,000 when you apply for the HELOC, you calculate your maximum line of credit by taking $200,000 x 85% = $170,000, and subtract off what you owe, $50,000. This gives you a total of a $120,000 line of credit.
Every lender can have different criteria to determine your maximum line of credit.
Most often there are 2 phases with a HELOC, a draw period, and a repayment period. The draw period may last 10 years, and your repayment period could be the 20 years following the 10 year draw period. You are not required to use your available credit during the draw period (there could be a minimum usage fee with your lender), but there are usually minimum payments that you need to make monthly if you do access the credit. They could just be interest only payments. Again, this varies between lenders. You have the right to pay down the principal at your own discretion.
After the draw period, you no longer get to draw on the credit, and you will have a set pay back plan during the repayment period. It’s important to know what the contract states, for rules, fees, payback terms and potential decreases in your line of credit. If you educate yourself on the front end, you’re less likely to be surprised down the road.
- Access to equity otherwise stuck in your home
- Free to use credit where you like
- Real estate is a slower moving financial vehicle than stocks
- Less volatility and most likely won’t have note called, BUT you should know what your contract states if your home value drops
- Some flexibility with pay back schedule during draw period
- Could use to pay down higher interest credit card debt for example
- If you over leverage yourself and can’t make payments, you could be forced to leave your house
- Your house is the collateral
- If real estate market drops, your line of credit could be decreased
- You could also end up owing more than your real estate is worth
- FEES-this will vary with every lender
- Annual, transaction, inactivity, early termination, minimum withdrawal
Traditional bank deposits
I think everyone is familiar with this vehicle, so I don’t need to walk through what it is.
You could collateralize a deposit. You would need to put money in a certificate of deposit (CD) with the bank you want to do a loan with. I have in fact done this, before I knew what infinite banking was.
The first thing we get with this type of loan is terms from the bank. They tell you what the interest rate will be, how much you can borrow (this will depend on the collateral you have), how many months the loan will be for, and what the interest rate will be. Most likely there will be quite a spread between your CD interest rate and your loan rate, that’s because the profits of the bank are shared with its stockholders, not the depositors.
In a worst-case scenario, the bank could have a management change or regulators that come in and say the bank is undercapitalized (thanks to the practice of fractional reserve banking). This may lead to them calling your note due. If you can’t pay it, they would have the right to seize your deposit. I want to say this is unlikely to happen, but 2008 wasn’t that long ago. Many banks needed bailed out or went out of business. We have no idea if this could happen again, but I can tell you that as long as fractional reserve banking exists, it is a possibility.
- Convenience for depositing (direct, walk in, online)
- For me personally, my bank has good customer service
- Low growth potential currently
- You won’t share in profits (maybe some exception to this at credit unions)
- Banks are leveraged and could become undercapitalized
- Compounding is interrupted by taxation
I do realize that this is a short list. There is a vast number of financial vehicles that people use, so I just tried to pick 3 common choices. I hope you can see the limiting factors of why these products don’t work as well as dividend paying whole life insurance to Become Your Own Banker.
I did focus on the downfalls of these products and not the strengths. These are the strong reasons and risks you would have to knowingly take on though if you preferred securities, HELOC’s, or a traditional bank using CD’s. Of course, it’s easy to think the market will keep going up, real estate appreciates in value, and my local bank won’t have any trouble, but the risks do exist.
Mutual life insurance companies have the strongest financial track record of achieving growth and safety, and so it makes sense to use their product with more guarantees than anything on the market (dividend paying whole life insurance).
We will come back soon with an article focused on WHY we teach clients to use dividend paying whole life insurance to perform the banking function in their life at the you and me level.