Franklin Financial Group Blog

In this economic market, many people see their assets reducing in value by significant percentages. Recently, I have had a few customers who have second mortgages on their homes (whether actual loans or lines of credit) go to someone like their parents and suggest "Mom and Dad" lend them enough money from their retirement to pay off the second mortgage. Instead of paying the money and interest back to a bank, they are now paying their parents the interest. Of course this type of move carries with it the same risks banks have by holding the second mortgages, but if the person who has the loan is willing and able to pay it back as agreed to the bank, it might be a way for Mom and Dad to get a guaranteed rate of return on their money, which they might not get in "the market" right now. Their are tax consequences to consider when doing this, so consulting appropriate attorneys and/or tax advisors is suggested. When you pay interest to a lender on a mortgage that interest is reported as tax-deductible. Here's an example of how everyone can win. Let's say the interest rate on the second mortgage is 9%. If the person paying on the second mortgage is able to deduct the interest on their taxes, and is in the 33% tax bracket, they are "effectively" paying 67% of that interest (100% of the interest paid to the bank minus the 33% tax bracket portion they deduct.) 67% of the 9% interest rate is equal to 6.03%. Let's assume Mom and Dad agree to lend the money to their children at a rate of 5%. Mom and dad would win because now they are getting the rate of return in the form of payments from their children, which while only at 5% is possibly still a higher rate of return than they might be earning on their money in the market. The children win because they are now paying in this example 1% less on the money than they were paying to the bank. They also no longer have a second mortgage recorded on the home, unless a new one is filed and recorded.

Let me reiterate that making a decision like I am describing above should not be made without first consulting with your tax advisor, attorney, or financial planner. If done correctly however there are definite benefits for all parties involved. One benefit I have not mentioned is that this type of conversion will eliminate some of the risk banks are carrying on their books, which will free up money for them to lend back to the public. I am no economist, but it is my belief that this could result in improving the position of some banks, reduce the interest some borrowers are paying on presently and increase the rate of return for investors, all in one move.