Infinite Banking Options
In Robert Kiyosaki’s book, Rich Dad, Poor Dad he talks about how rich people put their money to work while poor people work for their money. His definition of rich and poor are not predicated on income or material possessions, but on how you view money.
A household making a six-figure income living in a spectacular house and driving BMWs may be defined as poor by Kiyosaki’s definition while a household making the same income living in an average house and driving Honda Civics but investing their discretionary income would be defined as rich. Why? Because the household spending every dollar they earn on possessions and experiences is caught in a perpetual cycle where they must trade their time for money. The household focused on prudent investing is putting their money to work. Over time, the money at work will allow the second household to spend their time however they want while their invested money provides them with the lifestyle they want to live (within reason, of course).
Putting your money to work on your behalf is one of the foundational concepts of building wealth. Save your money, buy a rental property, and now your money that was sitting in the bank not making you anything is now generating 10% annually.
The concept of infinite banking takes this concept even further.
Put Your Dollar to Work Twice
The concept of infinite banking is based on the same concepts that a bank follows to make money. In simple terms, a bank can make one dollar do the work of two dollars.
Let us pretend that I open a savings account at the bank down the street. My initial deposit is $20,000. The next day, you come into the bank and ask for a loan for $20,000 so that you can go purchase a car. The bank is going to take my $20,000 on deposit and loan that money to you. I still show that I have $20,000 on deposit at the bank, but you have just used that money to go and purchase a car. In simple terms, the bank has taken $20,000 and turned it into $40,000. My $20,000 in savings and the car dealership’s $20,000 for the car you just bought.
Now actual banking is far more complex than the example that I provided, but the basic concept is still the same. One dollar can do the work of more than one dollar.
The ability to use your money twice is not just a concept for the banking industry. There are several ways that you and I can put the same dollar to work multiple times.
Borrow From the Retirement Fund
One of the easiest ways to do this is to borrow from your retirement fund. Tapping the 401K for a loan allows you to continue to make money in your 401K while putting that money to work for you elsewhere.
When taking a loan from the 401K, you generally agree to pay your 401K back at a high-interest rate (5% to 6%), and you agree to pay back the loan in a short amount of time (5 years or less).
In my opinion, this is the least effective way to make a dollar work for a couple of reasons. First, the payments back to the 401K are relatively large. If you are looking to loan yourself the money to buy a car, your monthly payment is probably going to be higher if you borrow from your 401K vs. borrowing from a bank (assuming you have decent credit).
If you are like me and you are looking to tap into that 401K money to invest outside of the stock and bond markets, you are probably going to be cash flow negative in the transaction. Most investments that would pay enough to allow you to repay your 401K without having to come out of pocket are probably too risky to justify pulling money out of your 401K.
The other issue with this move is that the 401K invested in stocks should, over time, deliver a higher return than the 5% you will be paying yourself in interest.
Another problem with tapping into the 401K is that it is cumbersome. It takes weeks to access your money, the payments are usually deducted directly out of your paycheck and paying extra on the loan is difficult if not impossible. My experience has been that the only early payment option is to pay the funds back in full.
A final point to consider. If you fail to pay the loan back (which is an option), you will be taxed and penalized for making an early withdrawal from a retirement account, so be careful. If you get into a situation where you are unable to pay this loan back, you could face tens of thousands of dollars in tax implications.
When trying to make your money work even harder, I think this is the least preferred method.
Use the Equity On Your House
In future articles, I will discuss how I went about tapping the equity in my home to invest in more real estate and earn more money each month.
With this tool, you purchase your house with a combination of a down payment and a bank loan. As you build more equity in a property, using the equity in your home allows you to lower your monthly payment and/or leverage equity to invest.
You can do this using a Home Equity Line of Credit. The catch to this is that you need to have paid down enough on the balance of your home loan before you use a HELOC to be cash flow positive. Buying your house with 20% down on a 30-year mortgage and then trying this method will create a higher monthly payment than your original mortgage payment. Be sure to do your homework.
Take a homeowner who has a 15-year mortgage and has 5 years left on their mortgage. If they bought their house for $200,000 at a 3.5% interest rate, the payment would be ~$1,800 each month and the balance on the note would be around $80,000. Paying the loan off using a HELOC would drop their payments down each month to less than $1,000 and provide the homeowner with access to that equity.
I like and have personally used this tool for investing in additional real estate deals. I like this method because you can use your equity immediately. The risk of using a HELOC is that you are borrowing against hard-earned equity. Proceed with caution.
Be aware that a HELOC goes on your credit report, and many lending institutions will automatically assume that your HELOC is fully drawn. If you have a limit of $200,000, but you only owe $20,000 on the line of credit it is possible that a bank will factor in the full $200,000 when calculating key financial metrics. If you are looking to get a loan, you will need to consider the impact that this might have on your borrowing abilities.
Whole Life Insurance
A whole life insurance policy is another financial vehicle that you can use for infinite banking. Whole life insurance policies are life insurance policies that you pay into and can serve as an investment vehicle. For life insurance policies, these are not all that effective because the amount available at death is your invested amount plus earned interest. It takes time for this policy to adequately protect loved ones in the event of your death.
However, whole life policies are probably the most effective way to put one dollar to work multiple times.
Like the 401K and the HELOC, you are loaning yourself money when you draw from the whole life policy. However, your payment reschedule is more flexible. Loaning yourself money from a whole life policy does not appear on a credit report, and the proceeds made on a policy are not taxed by the IRS.
The challenge with the whole life policy is that there are fixed fees and payments required for the policy itself. If you are looking to take out a policy and you plan to start the policy with $50,000 or $100,000; these fees and payments are insignificant, but if you are starting out with $1,000 or $2,000, the fees and payments required make this tool cost-prohibitive.
It is possible to make your money work overtime on your behalf, and we will be diving into more details on the HELOC in future posts.
I would encourage you to do your own homework on what tool is best for you if you are looking to redeploy capital into investments. I would also caution you to make sure that you are making sound and wise investments and that you diversify as much as possible.
I would also encourage people to make sure that they are careful and prudent in how they use these funds. Tapping into your retirement or using the equity in your house can put your future financial health and your home at risk if you fail to repay the borrowed funds. If you haven’t learned to master the credit card, this is probably not a tool for you.