Personal Finance 101
Asked by Anonymous
Asked on 05 Dec 2018
Such arrangements are actually more common when utilizing your mortgage, or any other asset that you might own in order to gain a low interest rate. With a low interest rate and freeing up a large asset to invest the difference in something like an endowment, you make consistent money between the two differences in interest.
E.g. If the Endowment pays 4% a year and your interest a year is 2% - 2% of 1.5mil is a cool $30,000 a year, or $2500 of free money a month that you have.
Obviously necessary precaution has to be taken to execute this as its far more pleasant in theory. The reality can be quite complex, but its the financial advisor's job to execute with professionalism. You may want to take a more active role in the process before letting him/her automate it once a couple of payouts are secure.
he can provide a low FIXED rate throughout the loan tenure. Endowment plans maturity yield will be on the lower spectrum. Yes, u are utilizing leverage, simlar to mortgage. But the potential upside for property investment is much higher compared to endowment. It is NOT arbitrage.
Also bear in mind that endowment payout is at maturity, as oppose to property investment where rental income if planned properly can cover most of the mortgage repayment. If anytime before the maturity u get into cashflow problems, u will lose out big.
If u are taking on floating rate loan, u might be facing a rising interest rate environment as of now. That will significantly eat into any positive roll u are expecting at the end. Endowment's performance are sort of capped, the insurer is unlikely to increase payout above the projected values. You will suffer if inflation is higher than expected in the long run. For investment property, u are still able to raise rental rates to offset rising rates.
In technical terms, u are like borrowing short(borrow at floating rate from bank) and lending long (lending money to the insurer long term at 'fix' return). This can be a risky venture for u. For a positive roll of only a thin margin is not worth the risk.
Also, Why borrow to leverage the commission your advisor gets.
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Yes, I have heard of such arrangements. In an increasing interest rate environment, the rate of return may not be sufficient to cover the interest, especially if there is a sudden spike in interest.
It really depends on the premium financing interest (loan %) and the absolute return versus the amount you put in.
example: you loan $750,000 to get a $1,500,000 endowment.
the loan payment is $22,500 but you get $37,500
overall return is $37,500 - $22,500 = $15,000
amount you put in = $750,000
XIRR = $15,000 / $750,000 = 2%. Is it good? Maybe if we put in less capital.
Edit: I have a feeling the advisor is more towards mentioning Universal Life because this is the first time I heard for endowment. It is very common for universal Life but I wouldn't advice to go for premium financing (since Universal Life is a step up term insurance, meaning the cost of insurance increase as you age)
Top Contributor (Jan)
This is called arbitrage/leverage.
You earn a higher return on the total policy than pay interest on the borrowed amount.
You borrow money to buy an investment home to earn rental income plus appreciation.
Same concept, but even better, because you don't have to pay maintenance, commission, and other charges.
In fact, you can double leverage when getting such a high policy and can possibly give you a 9-10% return on your capital for life.