Taking a loan from the bank or a financial institution can help keep your business running, but it can cost you thousands of dollars in interest payments in the long run. A report by Experian shows that an average consumer borrowed over $92,727 in 2020.
One way to avoid interest payments is by adopting the cash flow banking procedure. Cash flow banking reduces your dependency on financial institutions and lenders for loans, thus reducing the money you pay for interest.
The concept is quite simple – whenever you need money for the working capital or personal requirements, you borrow from an insurance company or yourself. Now, this method may sound like an impractical option for small business owners. So, how does it work? And, is it even possible to borrow money from yourself? Let’s find out in this post.
What is Cash Flow Banking?
Developed by Nelson Nash in 1980, the idea of borrowing money from the life insurance policy became a popular money-saving tip for individuals and businesses that needed loans frequently. Borrowing from yourself means using your life insurance policy to cater to your financial requirements. Let’s see how you can do that.
Find a mutual insurance company that offers loans at a fair or comparatively lower interest rate than the banks. In this concept, the policyholder can get a loan from an insurance provider using the cash value of their life insurance policy. In simple words, your life insurance provider will work as the bank that lends you the requested amount. The only difference between traditional banking and cash flow banking is that the latter earns you interest for borrowing money from the insurance company.
If the borrower passes away without repaying the loan, the insurance provider will deduct the remaining balance from the death benefit. The biggest advantage of using the cash flow banking system is that you can save money on hefty interest in the long run.
Which Insurance Policy Do You Need for Cash Flow Banking?
There are many insurance policies, but the most popular options are the term and whole insurance policies. Term insurance is your best bet. Not only is it cheaper, but it offers you coverage for a long period. A whole life insurance policy, on the other hand, is a little expensive. However, it lasts for your lifetime. So, you don’t have to worry about outliving the insurance. These plans can cost you higher than $1600 annually.
The term insurance costs you around $20 to $30 per month, on average. This means you pay anywhere between $240 and $360 every year for your term insurance. However, you can only use the whole life insurance policy for cash flow banking. That’s because you use the cash value of your life as collateral so that if you die before repaying the loan in full, the insurance provider can pay back the remaining amount from your death benefits.
How Does Cash Flow Banking Work?
The process is not as simple as the concept. You are supposed to purchase the whole life insurance policy and wait for a long period until the value of your plan increases. Once you are eligible for borrowing against your whole life insurance policy, you no longer need to take a loan from a traditional money lender or bank. It may sound quite weird, since borrowing from yourself does not make any sense. However, the reality is that you borrow money from the insurance company’s “general fund”.
The insurance company lends you the requested amount from their General Fund, using your whole life insurance value as collateral. That’s why you need to buy the insurance as soon as possible. It may take many years to increase the value of your policy so you can use it as collateral later on. If you are planning to borrow a large amount, it will take you decades to increase the cash value of your whole life insurance policy. So, it is quite obvious that this strategy may work for small loans, such as for education or wedding. If you are looking to finance the down payment for your house, reaching out to a bank or a credit union is your only option.
Building the cash value of your whole life insurance takes decades given that you pay the high monthly premiums regularly. That’s why it is often considered an ideal option for wealthy people who have enough money to pay premiums regularly. The advantage of borrowing from yourself is that insurance companies charge a considerably low interest than traditional banks. Plus, there is no hassle of paying the money back within a specific period. You have used your whole life insurance as collateral, so even if you are unable to repay the loan, the insurance provider will deduct the outstanding balance from your death benefit.
How to Manage Cash Flow?
Having a positive cash flow is the best way to avoid loans and interests. You don’t even need the whole life insurance policy if you manage your business’ cash flow properly. Having a positive cash flow throughout the year is not a cakewalk. In fact, many business owners need cash flow loans to deal with the financial crisis. Here are a few steps to manage your business’ cash flow:
- Monitor the cash flow every few days
- Deposit cash into your business account to avoid unnecessary expenses.
- Cut back on the rental payments, utilities, and payrolls
- Sell equipment or fixed assets you no longer need
- Lease heavy machinery and plants instead of spending thousands of bucks on buying them
- Send invoices immediately
- Offer exciting deals and discounts regularly to increase your cash flow
- Ask for cash deposits in advance for large orders
- Use business credit cards to keep a positive cash flow
- Negotiate with your vendors and clients before accepting the deal
- Get cash flow loans
These were only a few ways to save money and increase your cash flow. There are plenty you can try for effective cash flow management.