A year or two ago I received a phone call from a couple that I know, but that were not clients. The wife was on the phone and told me that they were about to sign refinance papers on their house the next day but were having reservations. They wanted to get my opinion on what they were about to do. I listened to their story and told them that they had to come right down and talk to me before they moved forward. Their foresight to call may have saved them from financial ruin.
He Wants You To Do What?
A few weeks earlier a man had come to their house. He presented to them a new way to give more security to their family, pay off their home quickly and save for their retirement. All of this would be possible without any money out of their pocket. How was this miracle possible?
He told them that all they needed to do was to refinance their home, taking out every penny of equity that they could get, using a reverse amortization loan. They would then place all of the proceeds of the loan in a Variable Universal Life Insurance policy (VUL). They were also to begin putting hundreds of dollars per month into the policy as a premium. Then, like magic, the loan on their house would grow, but at a much smaller rate than the value of their home. In the mean time, the investments in the VUL would grow at 10-12% or more per year.
After the investment had grown at a great rate for a number of years they could take it back out and pay off the balance of the loan. In fact, this was such a perfect plan that he told them they should take all of their money out of their retirement account at work (even with the penalties) and invest it in this VUL as well. And to top it all off, the VUL would provide life insurance that would pay off the loan in the event of their death. Why hadn’t someone thought of that before? (By the way, the commission that this guy would have earned on this deal would have been very nice!)
RUN! This was a scam if I had ever seen one. Perhaps in the best possible scenario this scheme would work – I don’t know. I haven’t bothered to spend the time with the numbers. All I know is that I never plan on the best possible scenario because I have never seen it happen. To me this was a recipe for disaster. This couple was not in a position for a house payment that would go up in the future. They didn’t need the amount of insurance that he was suggesting. They certainly shouldn’t take the money out of the employer retirement plan. What would happen if it didn’t work out?
Looking back now I can’t believe how bad it would have been for them:
First, interest rates began to go up. They didn’t have the money to pay any more than they were on their home. They would have been in real financial trouble.
Second, they have since tried to sell their home (for other reasons) and have not been able to at all. If they had not been able to make the increasing payments they could not have gotten out of the home.
Third, the value of their home has dropped significantly. As it is they don’t have much equity left in it right now. Had they gone forward with this scam they would be seriously upside-down in their mortgage to home value.
Fourth, I don’t know the specifics of that VUL, but I doubt it has done much better than the market – likely worse because of the high internal fees of a VUL. It is very likely that the money that they had put into it would be worth quite a bit less today.
I am glad to say that they followed my advice and they are much better off for it today. They bought a very inexpensive term policy on their lives (that they could actually afford) and kept the rest the same.
Warn Your Neighbor
That was the first time that I had heard of this scam. I have run into it three other times since then, so it’s a growing trend. Now there are seminars that you can go to and learn how to make such a “wise” investment. There are even two multi-level marketing organizations that I am aware of that are touting this scheme to their customers (victims). Better yet, they have figured out how to make even more money from the whole deal. I am aware of one group that will do the refinance (and make a commission) and then do the investment (and make a commission).
Surprisingly a lot of people are falling for it. “Too good to be true” still seems to sell very well.
* This article is commentary on basic principles. In no way should the things said in the article be construed or interpreted to be advice for your specific situation. Before making any financial decision you should consider all factors and consult with a professional.