Beware of financial advisers who tell you to borrow against your home to invest in expensive life insurance policies.
Question: My advisers came by the house last night and gave me a 90-minute sell on how I should borrow $200,000 against the value of my house by taking out an interest-only mortgage and then invest the loan proceeds in a life insurance policy. They said this would preserve my liquidity and maximize my tax write-offs. I am very skeptical. What do you think? -Paul Terris
Answer: It’s nice to see that, like me, you’ve developed what I like to call a B.S. Detector, a sort of sixth sense that sets off warning bells whenever you’re the target of a suspicious investment pitch (or, during the campaign season, unrealistic political promises).
And based on what you’ve told me, my B.S. Detector is wailing like a banshee for two reasons.
First, far from a reasonable strategy to put you on a more sound financial footing, what your advisers (and I use the word loosely here) are proposing seems more like a plan to sell life insurance.
I’m not surprised by that, I’ve warned people before about the veritable army of life insurance agents, financial planners, brokers, etc. out there who recommend high-cost life insurance policies as investment vehicles when plain old mutual funds or ETFs or stocks and bonds could do just as well.
But your so-called advisers have upped the ante. They not only want you to invest via life insurance, they want you to borrow the money to do it.
This means you would have a loan you’re liable for that you didn’t have before, as well as payments to make on that loan. Sure, those payments may seem low at first if you’re paying only interest. But eventually you’ll have to pay off principal too. If the rate on that loan is adjustable, as opposed to fixed, you could be hit with a double-whammy if rates go up at the same time that required principal payments kick in. Indeed, many of the homeowners who have already lost their homes or face foreclosure now got in trouble because they weren’t able to keep up payments on interest-only and other “alternative” mortgages.
The idea, of course, is that you’ll come out ahead as long as the return on the investments within the policy exceeds the rate on the loan. That may seem like a no-brainer, but there are any number of reasons why that may not happen.
In your case, you’ve also got to consider that the types of life insurance policies that are sold as investments are typically larded with all sorts of fees and expenses, including a nice hefty commission for the person selling the policy, that can drag down your return.
As to how this “preserves your liquidity,” I’m not sure. Before this transaction, you would have $200,000 in home equity that you could tap if necessary through a loan. Soon after this transaction, you’ll have something less than $200,000 in cash value that you can withdraw from the insurance policy. How much less will depend on what you pay in commissions, sales charges and other fees. But whatever the figure is, you will likely face withdrawal charges of some sort for many years if you wish to pull this money from the policy. (Yes, you may be able to take out a policy loan, but then you would be borrowing against money you’ve already borrowed. That strikes me as a tad inefficient.)
I’m sure your “advisers” have all sorts of charts and projections that purport to show how you’ll come out ahead in this little scheme. They always do. But no presentation can get around the fact that it’s just plain risky to invest borrowed money and that life insurance is an expensive way to invest.
So my recommendation is that you heed your skepticism and pass on this proposal. And while you’re at it, you might want to look around for some new advisers before these guys come back to you with another dubious plan.