There is no limit to the number of financial personalities that will over complicate a simple idea. The Infinite Banking Concept is no exception to this rule. In this case, this phrase “Infinite Banking Concept” is most popular among life insurance sales people bent on selling whole life or Index Universal Life (IUL) as a financial product.
In its simplest form, the infinite banking concept is nothing more than borrowing money while investing. Or more accurately, it’s the act of borrowing money INSTEAD of withdrawing from investments. Since Whole Life and Index Universal Life is so expensive, guys like Doug Andrew will use arguments around the Infinite Banking Concept to convince people to purchase these high commission products.
In this article, I want to explain the Infinite Banking Concept, give alternate names for this concept and provide a few examples in order to demonstrate how to implement this idea outside of expensive products like Life Insurance.
What is the Infinite Banking Concept?
Infinite Banking, in its simplest form, is the concept of taking out a debt instead of selling assets to make purchases. I believe the label “Infinite Banking” came to be as an extension of the book ‘Becoming Your Own Banker’. (This is an affiliate link to the book, however, I don’t recommend you read this book for its ideas. If you’re interested in what motivates the life insurance sales person, it’s an interesting read. However, it reads more like confusing web of concepts that end with the argument that life insurance is a financial vehicle.)
In the book, the author walks the reader through the idea of using cash value life insurance products, like Whole Life Insurance, like it’s a personally owned bank. His argument is that if you treat it like a bank, and then you become a customer of your bank, you will have a product that acts like banking system owned and operated by yourself as opposed to be owned by the wealthy elite.
While this message may have a strong impact on people, this idea isn’t new. Nor is life insurance the best product to achieve this goal. Also, you can’t be your own bank. The analogy breaks down pretty quickly when you apply an amount of scrutiny to the concept. But that’s not the point of this article.
The infinite banking concept works like this. Let’s say you bought $20k assets that are growing at an average rate of 10%. It’s been growing for the last 20 years and now you need to withdraw some of these funds for a major purchase like a car or home down payment. The value of your account will be around $135k after the years of compounding.
You have two options. You COULD withdraw the money you need, but you will owe taxes and the account will now be growing at a slower rate due to having less equity. ORRRRRR, you could take a loan out. Let’s say we have a 5% loan. Our assets will continue grow at a rate of 10%, and we now have our cash, tax free, and it’s costing us half of what that same money is growing at.
So even if you take a loan for the entire amount of the account, $135k will grow by $13.5k and the loan would cost of the loan will cost us $6.75k. The net result will be a gain of $6.75k. So instead of paying taxes AND losing all that growth, you get that growth, pay no taxes and get access to the money.
Even if the Infinite Banking Concept is primarily sold as a feature of Cash Value Life Insurance, these features exist in a lot of financial tools and methods. One of the biggest benefits to these other methods is that they don’t carry the fees and costs of purchasing an over priced life insurance policy.
Examples of Infinite Banking
In the intro, I complained that financial influencers will often over complicate concepts. I’m not entirely sure why they do this. I think in some cases they may not entirely understand the ideas they are pushing. I think others may be attempting to appear smarter than they really are.
So I try my best to explain the concepts as simply as possible. We covered how asset growth vs loan rates can produce a net increase in equity. So you’re probably like “Ok, you sold me on the idea, but how I do I do it?” Let’s walk through a few examples of how to implement the Infinite Banking Concept in the real world.
NOTE: It’s important to note that all of these methods come with various levels of risk. Taking out debt inherently has risk attached. I am not covering risk in this article. Knowing and understanding the risk is an important step before moving forward.
Life Insurance
As much as I dislike the idea of using Life Insurance as a financial vehicle (I wrote an article debunking the main arguments for using Life Insurance as a financial vehicle) I would remise to not explain how this works. Especially since this is the primary method when using the label “Infinite Banking”.
The idea is to over pay into your Whole or Index Universal Life insurance plans. This over payment will generate a “cash value” on the side. Insurance companies are required to pay interest on this money. The insurance company will also offer loans that can be taken out using the cash value as collateral.
As long as the loan rate is lower than the average return on the account, theoretically this idea works. It comes with a lot of costs, but technically you can build wealth, take out loans to avoid taxes and the cash value will continue to grow over time.
This may be the easiest method, but also the most costly. Your representative will easily be able to walk you through this process.
Real Estate
Real Estate may be the toughest way to accomplish infinite banking, but it’s also the most powerful. There are a few methods to accomplish this task with real estate, but I’m going to highlight the refinancing method as it’s the simplest to grasp.
Real Estate appreciates around 4% on average in the United States. For the sake of argument, let’s say we have a home in an area that is appreciating at a rate of 6%. Most home loans, excluding the rates of the last year or so, have been below 6%.
So we purchase a home, and put as little down as possible. For the sake of simplicity, the homes value at purchase is $100k and our loan is an even 3%. If we do nothing else but live in this home and pay the mortgage, the home will appreciate at a rate of 6% and the loan will cost us only 3%. This produces a net benefits of 3%.
As time goes on, you will build more equity and the amount on the loan will become smaller. So we can restart this process by refinancing. We take out the equity and let’s say we get a new loan for 3%. We can repeat the process every 5-10 years.
This method may be a little slower and it takes awhile to gain access to that equity. But this way, we don’t have to sell the home, we get access to the cash, pay no taxes, and we can continue this processes in perpetuity.
Brokerage Account
It turns out that you can implement the infinite banking concept with a simple brokerage account that is available nearly anywhere. Most brokerages will allow you to purchase stocks, bonds, options and then borrow against these assets.
This is the route I personally like the most. I purchase lower risk, highly diverse, index funds like an S&P 500 index fund. These may be somewhat volatile, which adds to the risk of taking out debt, but they have a great long term average.
Most brokerages will then have the option to take out a loan against this account. E*Trade, for example, calls this a “Line Of Credit” account.
In this example, the S&P 500, on average, will appreciate at a rate of 11% per year. If I were to take out a loan against these index funds, that loan might average around 7% annually (It’s important to note that these loans are variable interest). If I were to take out a loan, I could access my money, pay no taxes, and continue receiving a net benefit of 5% a year on that money.
Another major advantage to these types of accounts is that the interest owed on the loan can be added to the loan itself. So unlike our real estate example, we don’t need to find the cash to pay the cost of the loan. We can choose to pay it down over time, or we can let the interest continue to roll into the loan and simply purchase more index funds to decrease the debt to asset ratio.
This is another fairly easy way to achieve the Infinite Banking Concept. Most brokerages will offer a specialist to walk you through how to achieve these goals at no extra cost to you. But again, I must reiterate the risk.
Vehicle Purchases
This is a very interesting one. The idea is basically the same as before, but any time we have the option to take out debt at a rate lower than our assets are appreciating, we have the ability to achieve infinite banking! As a result, a vehicle purchase presents an interesting opportunity.
The idea is that you have investments worth the amount you need to purchase the vehicle, or you have the cash for the vehicle available for the purchase. This does not work if you have loans already out against your assets or you are simply buying a vehicle on a loan without having the assets or cash.
The next step would be to either leave your investments alone, or go invest the cash you have into something with a solid long term average like an S&P 500 index fund that is appreciating at an average rate of 11%.
Secondly, and this is very important, make sure to pick a price point for your new purchase that would work if you were purchasing a car with cash. There is a tendency in our brains to allow more of a purchase when doing this method. However, the goal isn’t to spend more money. The goal is to produce money on items we were purchasing any ways.
Thirdly, go buy the car with the cheapest loan you can find. If you can manage to find a 0% interest rate loan due to some deal a dealership is offering, that’s the ticket you’re looking for.
This doesn’t really produce you a net benefit. The car itself is going to depreciate and the end result might be a wash. Your investments will probably grow enough to cover the cost of interest paid on the loan and the depreciation of the vehicle but not much more than that.
This idea around purchasing vehicles is more of a trick to tap into the an infinite banking process on a purchase you intended making anyways. Ultimately giving you an advantage over simply purchasing the car outright.
My View on Infinite Banking
The infinite banking concept comes with a lot of risk due to the basic nature of taking out debt. Any time debt is involved, it adds a new level of responsibility that must be prioritized above any other expenditure or your financial future is doomed. Dave Ramsey learned this lesson the hard way by taking out tons of variable rate debt only to see the housing market crash around him.
However, if you have the means to mitigate this risk, you’ve done your research and you feel confident in your abilities and knowledge, infinite banking can have some fairly incredible wealth building advantages. If your assets can continue to grow and you touch very little of your actual wealth, you will pay less in taxes, your assets will compound at a way higher rate and you’ll end up having significantly more wealth than you otherwise would have.
A fun experiment is to adjust the percentage of your gains in the compound interest calculator by just a percent or two and see how that can impact you over a significant amount of time. If you were to invest $1k a month for 35 years at a rate of 11%, you’d have just over $4 Million. If you invested the same amount for the same time at a rate of 13%, you’d have just over $6.5 Million.
In this case, the difference of just a few percentage points results in difference of $2.5 Million! That’s a lot of dough! It’s no wonder that the wealthy have been using this concept long, long before the phrase “Infinite Banking” ever came to be.
It’s important to note than none of this is financial advice and if you do choose to go down this path you are taking on risk that could result a bad outcome.
As for me, I deal in real estate, using this method on multiple properties that my guests are paying the mortgage for, adding another layer of growth. I have also purchases a car using this method and I’ve taken out loans against my brokerage account. Even so, my debt to asset ratio in my entire portfolio could withstand another crash like 2008 or 2020 crashes. I buffer my assets to not only weather the next crash, I built my portfolio to be able to take advantage if another crash does occur.
So please be careful with this information, but I hope you can use some of this information to achieve your financial goals!