Interest 'Free' Loans

H

HoustonHorn

250+ Posts
Apparently, you cannot do what you want with your money.

Sparing the details, my wife and I were going to borrow a large amount of money from her parents and pay them back w/ a very small/no interest rate. However, apparently, you cannot loan somebody money without charging "reasonable" interest. I'm interested in a way around this particularly idiotic law/code. Anyone have any experience with this?
 
The details are a 6.5% with 2nd mortgage rate or a 5.875% for a home equity loan. That and the 20% down payment required...which we can do, but why do that if we don't have to.
 
TBC...wasn't trying to taze ya. This just got popped on me today - I had no idea you couldn't loan your money to somebody. It's your money, so wtf, right? I was just providing the brief details.

However, the first person who says "if you're having to borrow it from your parents-in-law, you can't afford it," I will kill.

I just don't see the reason behind spending more money on interest payments to a bank when it could be going to fund my new daughter's college education. My wife's parents see things the same way, unfortunately, you can't do what you want with your money in this country.
 
have them loan you the money at a reasonable rate, pay them the principal and interest, then have them "gift" the interest back to you. I believe they can each gift each of you $11K per year without tax consequences

--check w your accountant to be sure
 
So why not pay 0.00001%? Seems reasonable to me. Or you could take it as a gift and pay the income taxes on it. Or you could just have them purchase whatever it is you want and pay them back in cash periodically.

Borrowing from the in-laws is a terrible idea though.
 
sawbonz...they are getting a home equity loan to do it...so they are already paying ~6%, then we have to pay an additional 5% +/- over that. I want to avoid the 5%. It's a loan against a house that is already paid off. The bank making the loan has the house as collateral. We pay the house off, so there is no other bank involved. We own that property.

fixing dinner, I will provide more details later....thanks!
 
There was once a fine line between "gift" and "loan" between family members, and people have abused it. The IRS now forces family members to charge interest. Otherwise, your oil tycoon uncle could just "loan" you a billion dollars interest free and you repay his estate/trust/family when you die.

The point of that is that the IRS does not want you paying interest to your wife's folks without getting a piece of the pie; thus they force a reasonable interest. I don't know if your parents technically have to "collect" the actual interest payment from you, but they must pay income tax on what that interest payment would have been, assuming a reasonable rate, whether you actually paid interest or not. That is between the two of you. In short, they are penalized for loaning their children money.

In reply to:
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So it sounds like they own a house you are going to buy from them, but they want all the money up front and hence the home equity loan? If so, just have them take the home equity loan, and have them do an owner finance set-up with y'all with your payment being the principal-and-interest from the HEL plus the interest you owe them, then have them gift you back the extra layer of interest. Or have them set up a 529 for your daughter and fund it w the interest you pay them.

Otherwise, it sounds like your in-laws are going to go into debt in order to loan you money to buy a house? If they are, don't taze me for saying so, but that sounds like one of the worst ideas in the history of ideas.
 
sorry...took me a long time to write that reply while I was cooking dinner. I missed several replies...I'll respond to each.
 
The suggestion is that your PiLs gift you the annual interest back. Not the principal.

Is your annual interest going to be over $22k?
 
I think the biggest issue is the tax implications. They have everything set up with their tax situation where any significant income screws things up. The issue is really why can't an adult make a contract with another adult without the government taking a cut.

This situation is complicated, and everyone's help is appreciated. It doesn't lend itself to a message board, so I apologize for not providing enough, or the right, information. My wife and her family are the tax experts, and I'm just trying to figure out a way around the government.
 
homer...the interest won't be over $22,000. The additional taxed income to them will be ~= to the rate we'd get to just go with the investment/2nd home financing. That creates a burden from an initial cash flow standpoint because we have enough to cover 10-15% up front, but not the whole 20%. Plus, it would be nice to have that cash available to fix up the place and rent it, put it into the 529, reserves for payments, etc.

Monetarily, there's not much difference, but cash flow up front makes a bigger deal - not that it isn't going to happen either way. I just want to figure out the best plan.
 
If the amount is less than $44K, the in-laws could just GIFT you the money with a non-binding understanding that you will be giving them a GIFT of a coincidentally equal amount in the near future. Hell, if it's less than $88K, they could just post date a $44K check to Dec 31, 2007, since the $11K gift limit is only an annual limit. Of course if you have children this number can be larger.
 
One other thing you may try is a lease with option to buy. We did this w my MIL, basically bought her a house and set their "rent" as equal to the P-I-T-I, so there was little to no tax implication for us as we did not make a profit from the rents collected. It works as long as P-I-T-I is close to what a reasonable rent would be.

The only thing I'm not sure about is how to handle the title transfer once it's paid off. I guess you could leave it in their name and figure it out when you're ready to sell.
 
Just curious, But how would the government know if they were to lend the money? What could they do to enforce? and would they seriously enforce it or apply penalties?
 
sawbonz...I'll look into that, thanks.

EPT...the problem is that her parents are both tax advisors, and apparently whoever does their taxes would notice the home equity loan and the "missing" money and it would raise red flags. The last thing I want is for them to get in trouble, but if there is a legal way around this, I want to find it.
 
Actually, the problem comes when someone wonders where you got the money to buy a house. Your in-laws can take out a loan and do whatever they want with it, including flush it down the toilet one dollar at a time. But if you suddenly have a $100,000 house and no loan and not enough income to buy it outright, it might raise flags. The only way you could have got the $100,000 is through a loan, gift, or income, and those would have to be documented with proper tax implications.

I'm not sure why you keep mentioning having to pay x% on top of whatever the bank is charging your in laws. This should work:
- Inlaws borrow $100,000 from bank on HEL at 5.25%
- You borrow $100,000 from in laws at 5.25%
- Your payments match up exactly with what the in laws have to pay the bank every month.
- Your in laws will pay income tax on your 5.25%, but the HEL interest may be tax deductible (conditions apply - consult your tax adviser - void where prohibited), so it could all come out in the wash.
 
misha:

Her parents are my tax advisor, and the problem here is solely the taxes paid because they have to declare it as income. That screws up their tax situation, and it means I'm essentially paying taxes twice (HEL 5.875% and Inlaws 5.875%). So it doesn't make any sense for me to do this and I should just pay a higher rate 6.5% for an investment property.

I just find it astounding that the federal government wants to take a second bite at the apple when this would be an agreement between two adults of legal age to enter a contract. I was wondering if there was any way around this.
 
I'm with mishatx: they take out 100,000 at 5.25%. They lend you 100k and charge you a reasonable interest rate of 5.25%. So every payment you make to them, they then make to the Bank. You don't HAVE to pay double the interest rate.

There is no way the statute says that you have to loan money at a reasonable rate IN ADDITION to any rate that you are paying on same funds. The only reason to pay double the interest is if they want to profit from the loan made to you, which is certainly reasonable.

Why doesn't this work?
 
The last thing they want to do is make a profit. That requires them to report it as income and screws up their tax situation.

The problem is that it is two separate transactions. The HEL is the first and has an interest rate of 5.875%. The second transaction is where the money goes from them to my wife and I. They cannot just give us that money without charging us interest. We were already going to pay the interest on the HEL because we were going to make the payments for them.

If it was a single transaction, I could see it, but its not, and they can't gift us that much money (not to mention other requirements on gifts), and they can't loan us the money without charging a "reasonable" rate of interest where the federal government determines what is "reasonable."

Maybe I'm missing what y'all are getting at. The biggest point is they don't want to have to declare it as income, so they were going to give us the money with no interest from them, but would include us paying the interest on the HEL.
 
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