Equity Harvesting

policy doctor

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The Wrong and Right Ways
To Use Equity Harvesting!

A few months ago I wrote the article ‘Equity Harvesting & CV Life Insurance!’ In the article we discussed some of the most frequently asked questions about Equity Harvesting. Questions like: “Does Equity Harvesting really work?” “Is Equity Harvesting Truly In Your Best Interest?” “Is Equity Harvesting Just a Scam to Sell Cash Value Life Insurance and Make Higher Commissions?” “What Happens When The Mortgage Interest Rates Rise?” I also stated in the article that… “Equity Harvesting, when done properly, is truly an invaluable financial concept when it comes to accumulating wealth.”
Obviously, I’m a great believer in Equity Harvesting. When it is done properly! I have been using and teaching the concept for 25 years. The problem is that most agents, advisor and planners are not being taught the right ways to use it! And, it’s now coming back to haunt them! Insurance companies are starting to receive complaints from policy owners who have been using the concept for three or more years. Many of these insurance companies have been compelled to put serious restrictions on the use of equity harvesting to avoid future law suites! Midland National won’t accept any business where ‘Equity Harvesting’ is involved. Aviva won’t accept business that involves refinancing, unless the client meets certain financial strength.
The Wrong Ways to Use Equity Harvesting
One of the biggest problems with equity harvesting appears to be the improper use of ‘Option ARM’ loans! In their effort to make as much money as they can from each client, many agents are focusing exclusively on using the minimum payment of the Option ARM. Their goal is to remove as much home equity as possible, to invest in cash value life insurance. And, they are neglecting to mention the future implications.

Many of the people, who have followed the advice of these agents, are now facing serious financial problems. Their minimum monthly mortgage payments, with the ‘Option ARM’ loans, have been increasing each year. Plus, in the past year, the values of homes have leveled off, and in some cases have declined. The ‘deferred interest’ they have been accumulating, with the ‘Option ARM’ loan, means they now owe more on the home than it is worth. These ‘Option ARM’ loans require that at the end of five years the borrower must either refinance their home, or start paying a ‘normal’ mortgage payment based on the higher loan balance they now have. In many cases these ‘normal’ mortgage payments will be more than double what they were paying.
Now these people have a serious problem. They owe more on the home than it’s worth! They can’t refinance their mortgage. And, because they were advised to remove as much home equity as possible, in many cases, they are already paying the maximum mortgage payment they can afford. So, if refinancing isn’t possible, where do they come up with additional money they need for the ‘normal’ mortgage payment, on a higher loan balance? They are in real jeopardy of losing their home!
If they want to keep their home, they are being forced to dig deep into the cash values of their new life insurance policy. However, because their policy is new, there is very little cash in the early years that they can use, without completely destroying the policy. They are now in a worse position then when they started!
What’s The Right Ways to Use Equity Harvesting
In my 25 years of using the ‘Equity Harvesting’ concept I have never recommended, or used the ‘Option ARM’ loan with a client. My sons and I do use the ‘Option ARM’ loans for our personal situations. Using the ‘Option ARM’ does allow you to free up the most equity and the most monthly income, but it does involve some risks, as mentioned above.

We believe that the ‘Option ARM’ loan should only be used if each month you save the difference between the minimum mortgage payment and ‘normal’ mortgage payment.
Why aren’t we using the ‘Option Arm’ loans with our clients?
The biggest reason we aren’t using the ‘Option ARM’ loan with our clients, is we believe they are just too risky for most people in the Middle Income Market! There are many unexpected financial challenges we face in our lives; medical bills, a new roof, car accidents, floods, tornados, layoffs, and the list goes on and on.
Plus, the ‘Option ARM’ loans are complicated, and are uncomfortable for most people. And, they can be expensive. (Refinancing costs, closing costs, etc.)
Then there are the questions about the deductibility of mortgage interest when you refinance to put home equity into a life insurance policy.
In most cases you can accomplish many of the same financial goals, without using an ‘Option ARM’ loan. You can reduce and/or eliminate consumer debt, free up money for savings, establish and emergency fund, and increase life style income.
Consider, if you use a Home Equity Line Of Credit (HELOC) you can “Harvest Equity” to pay-off credit cards, car loans and other debts. You can normally do this without paying any refinancing costs. Now you have freed up the monthly payments they were making for those loans.
Example: Your clients are currently spending $800 per month for $30,000 of debt. If you use a HELOC to borrow $30,000, at 8% it will cost them $200 per month. You have just freed up $600 per month that your client can now put into savings. ($800-$200) If they can average 7.0% on that savings in 20 years they will have $306, 244; and in 30 years they will have $705,639.
The biggest advantages are your clients are not locked into an $800 per month payment, and they can legally write off the mortgage interest on their income taxes (Up to $100,000)
Plus, it is simple and it is easy for clients to understand.
Now couple that with our other ‘Found Money Management’ concepts and you’ve significantly helped these people, without causing them to take unnecessary risks. It’s just smart money management.
Is anyone out there endorsing this concept? I know we've talked about the book Missed Fortune which touches on this, but this is a different variation. They teach this at the insurance pro shop.
Is anyone out there endorsing this concept? I know we've talked about the book Missed Fortune which touches on this, but this is a different variation. They teach this at the insurance pro shop.

I have researched this topic and think that it has it's place within a specific demographic who have a specific goal in mind of exposing themselves to a high level or risk for a moderate to high level or return. Anybody who endorses this approach w/out completing a full financial analysis for a client is performing a disservice and is acting unethical because you need to look at the big picture. People interested in taking risks for a better future w/ middle-upper to upper level incomes would be my focus if I pursued this avenue.

The calculations the author purported appear to be a 30 year fixed rate @ 8%. He doesn't take into account the miscellaneous fees, as well as a realistic financial picture of where somebody will be 20+ years down the road.

The Missed Fortune concept capitalizes on the financial tool of leveraging, which requires a bit of education to effectively use. I like the idea because the math works, but if I was to advise somebody on this it would involve a complete financial plan including savings, securities, real estate, etc. This type of investing is perfect to set yourself up as a financial planner, but not a life insurance agent who doesn't offer other services and does not have the education to back up his or her claims.

I'm going to start to pursue my CFP designation in the next few months, so I'm curious to see if this type of investing is going to be mentioned......
Where is the advantage of taking out equity and putting it on a perm policy thats reserves are invested in low yield debt instruments. Why not strip the equity and put in quality equity investments?
Where is the advantage of taking out equity and putting it on a perm policy thats reserves are invested in low yield debt instruments. Why not strip the equity and put in quality equity investments?

Like what type of investments? I do not agree with putting all of a families equity into a permanent policy, but I can see how it might be advantageous when examining a complete portfolio and goals...
The concern that I have is that there is a large, very large, number of people who have a cash value UL type of policy that is supposed to self-fund their insurance after a while or build large retirement funds and so on and so forth but in reality it blows up because it is underfunded. In my experience, very few of those people knew what they hell they had to begin with. It was sold to them and made sense at the presentation and in theory and if they were disciplined about funding it -but a week after the agent walked out the door they could not possibly articulate what they had to another person. So if you add a mortgage equity complexity to the equation it gets more and more complicated for most and so I wonder how it plays out for the average bear over time. I bet it turns into a mess for many.

Having said that, if there are select clients who are truly on the prowl for different techniques and have the discipline, intelligence, and intention span to go with it then I suppose it could be a consideration. It is not a concept that fits on a bumper sticker. And, there is a difference between a plan that is part of a total financial plan and the client is working with a planner versus a concept that is sold as a product solution and then the agent may or may not be seen again.

I'm thinking this article isn't all that well done and a lot of major points are not taken into account. First thing, any plan of this type is a long term stragedy, UL's need 4-5 years to fully fund while WL needs 7 years to completely be funded as noted in TAMRA, so the idea that someone comes along in the 3 year and say, "Hey I need to access this money", well obviously someone is out of whack. Now is that the client or agent? I really don't know but obviously I don't see why any agent or client would venture into this type of deal without making a long term commitment to each other and the "Plan".

Now the real discussion is two fold, "Leveraging Debt" and "Home Ownership". One is technical the other emotional, yet I'm not sure who is or isn't the best candidate for such a stragedy. Personally I believe the middle market is the obvious market, lets face it the HWC is likely already doing a variation to this idea to one degree or another, and really the profits seen with these Equity Plans is likely less then the HWC is already seeing with other investments.

Now home ownership, really this is strictly overused and misunderstood IMHO. Protection of the home, now is your home more protected if you have a large amount of equity in it or with no equity in it in the eyes of your friendly banker? In other words, in the eyes of the bank, if you have no equity in the house they are less likely to play hardball (vs if you had a large pool of equity in the home) in bad times, IMHO. Plus you can get a fix IO Loan, you can get one for up to 10 years I do believe, plus in ten years if you managed to keep good credit why would you just not get another Fix IO Loan? It isn't rocket science!

Now you have another strange twist in these scenarios by some, they suggest companies like F&G and not companies like Mass Mutual? Now historically who has a better payoff? The Mass Mutual, NYL, Guardian and others will out perform all other companies making them the cheapest as they are far more likely to do what they are suppose to do in the end or twenty, thirty or more years down the line.