Entrepreneur’s Wealth Digest
There is a fantastic transition that happens along the way while building personal wealth. You have the option to move from using outside lenders to fund your personal needs to leveraging your own assets. The question is at what level and how do you put the pieces together?
Lending tool kit
Below is a list of some of the major tools in your personal lending toolkit:
A 401k loan is fairly straightforward but not a tool that is used a lot. Essentially, if your specific 401k plan allows for it, you can borrow up to 50% of the account balance (capped at $50,000 in total). You repay the loan to yourself with a relatively low interest rate, usually WSJ Prime + 1-2%, and have 5 years to repay the loan. The biggest drawback to taking a 401k loan is that you are pulling money directly from an investment account, and you lose any investment gains on that money until the loan is repaid. I list it above as a tool you can use, but unless you are really down to needing a final $50,000 or less to accomplish something, you probably have better options.
Home equity loan
Home equity loans and lines of credit (HELOC) are probably tools you have used at some point in the past. As a quick refresher, you are securing a second lender beyond your primary mortgage, if you have one, and borrowing with the equity in your home as collateral. Having a HELOC in place can be a great tool for cashflow flexibility. If you have a $1M home with a primary mortgage balance of $600,000, you can likely put a HELOC in place for $200,000, as most of these equity lines and loans are capped at 80% total loan to value. Equity loans have a great place in your toolkit for flexibility.
Cash-out refinance of personal real estate
Cash-out refinances of personal real estate are another mechanism for accessing equity. In this case, you are simply refinancing with a single lender and typically staying within 70-80% loan-to-value. With the above example of a $1M home and the $600,000 loan, we are likely just refinancing that mortgage and taking out $100-$200,000 of cash at closing. These can be advantageous when you either have an existing loan with a higher interest rate or when you would like to stretch your loan term over a longer time period than is left on your existing mortgage. These are a bit less flexible because you are dealing with your total debt balance instead of just the equity portion.
Cash-out refinance of commercial real estate
Cash-out refinances of commercial real estate can offer some very interesting benefits that differ from cash-out refinances of personal real estate. This is based on a wider range of financing structures for commercial properties. Most personal real estate in the United States is based on a 30-year amortization with the occasional 20 or 15 year term used. Variable rate or interest-only loans are typically amortized over a 30-year period, even if their rate-lock or interest-only period is for a shorter term in the 5 - 10 year range. We less frequently see balloon payments or ultra-short rate lock periods of 1 - 3 years for personal real estate, but both of these are more common for commercial real estate. Based on the loan terms you currently have on your commercial property, you may have already set out to pursue a refinance in just a few years after purchasing. If you have added significant tenant improvements, bought in a fast appreciating market or proved up the business you own that leases the space from another entity, the property may be worth significantly more than a few years ago.
Let us use the example of a flex building with 2,000 square foot office space and 1,000 square foot warehouse space purchased for $1.3M two years ago with $300,000 in cash and a $1M loan. In this example, you were starting a specialty plumbing business without a track record and using the lease in order to secure financing for the building purchase with another entity you own. Your local bank gave you a variable rate of WSJ prime + 4% interest-only with a three-year balloon payment and the effective rate is approaching 9%. You are paying about $90,000 in interest cost alone. At the time, it was your only option, but now the plumbing business is steadily doing $4M of revenue, $1M of owner benefit and looks very attractive. The building itself has appreciated to $1.6M based on some system upgrades and general appreciation of similar spaces in the market. You can likely now secure a 70% loan-to-value (LTV) loan based on the 1.6% with a 15 - 25 year amortization and fixed rate and pull out $220,000 in cash at closing. The numbers here are just an example, but the strategy of using cash-out refinances of commercial property is something you should seriously consider as a method to build wealth and access cash.
Cash value insurance loans
Cash value life insurance policies are policies that contain both the insurance contract with the death benefit and an account that builds cash over time. As you pay your premiums either up front or over time, some of that premium pays for the cost of the insurance and some ends up in your cash account where it either earns interest, receives dividends from the insurer or is invested and earns a rate of return based on the investments. As this value builds up, you can access it via policy loans, where you borrow against the cash value and repay yourself interest over time. It functions similarly to a 401k loan and can be a tool that makes sense at times.
Portfolio lines of credit
Portfolio lines of credit end up being one of the most heavily used tools for cash needs and flexibility for wealthy families. They are set up via a bank lender who will use your investment assets as collateral for a line of credit. Imagine that you have an investment account of $10M allocated across a variety of investments. You want to buy a vacation property for $3M, but you do not want to liquidate your portfolio and pay the associated capital gains taxes. You also want to be able to make a cash offer, because the market is very competitive. Most lenders will let you borrow between 50-80% of your account value based on how volatile the investments are inside it. Even at the low end, you could borrow up to $5M in this scenario. Then, you pay interest-only based on the balance you have drawn. Let us say this is at 7%, and you borrowed the full $3M to buy the home. Your interest payment cost is $17,500 per month. Now, you have the home at the price you wanted to pay and can either keep the line of credit in place or secure a traditional mortgage at a lower interest rate and pay off the bulk of the loan. This tool is one of the most powerful for wealthy families because of the flexibility it provides.
Using your wealth to make access to capital easier and on your own terms requires a change in perspective. Most of these are not available at the same scale early in life, when we are just starting to build assets. Embracing them as you grow creates flexibility for you and your family. Deciding which tools to use and how to use them in concert is part of building your personal wealth strategy. There are always trade offs, and some of these can be complex to understand when used together, so review them with your personal wealth team or reach out to us here at Entrepreneur Aligned.
If you have a question or simply want to talk through your financial planning, we are here to help.
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DISCLOSURE: Jarrod Musick is an officer of Destiny Capital and Entrepreneur Aligned, a DBA of Destiny Capital. This article is for informational purposes only and should not be relied upon as a basis for your investment, business, or personal financial decisions. We recommend consulting with your wealth advisor, CPA/tax advisor and/or attorney, as applicable to your situation, prior to implementing any new tax, legal, or investment strategy.
Jarrod was born into financial planning and solving financial problems. With his financial advisor father Steve telling stories about finance around the dinner table from an early age, the idea that everyone has a different financial situation was always there. After an early professional career spent in nonprofit and government, Jarrod came back to his roots helping people plan and invest in 2011. Since then, he has worked with individual clients, led internal teams and ultimately became partner and the CEO of Destiny Capital in 2017. With a passion for helping entrepreneurs change the world, Jarrod ultimately oversaw the creation of Entrepreneur Aligned in 2020. With both Destiny Capital and Entrepreneur Aligned, Jarrod leads teams that help people live lives of abundance where money is simply a tool to let everyone be a positive force for the world around them. When he isn’t working with the talented teams for EA and DC you can find him chasing his twins, wily trout or a podium spot at an OCR race.