Author Topic: Interest free home loan - are we FI?  (Read 2969 times)

opnfld

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Interest free home loan - are we FI?
« on: November 24, 2014, 01:37:48 PM »
To avoid capital gains tax and landlording hassles, DW's parents bought us a house five years ago after selling their rentals.  We pay them market rent and when the total paid (minus taxes/insurance) equals the purchase price, the will give us the house (~15 years from now).  It's a great deal for us obviously and gives them cashflow without responsibility (i maintain the property) until their RMDs kick in.

But...

We plan to move closer to the in-laws in 2016 for a low COL and small town environment for our school-aged kids.  We want to relocate before our oldest enters 1st grade, but I'm not 100% confident that we will be FI by then.  In-laws have already agreed to let us rent the house out.  We won't benefit from cash flow, but rent will generate ~$19K in equity each year (after expenses).   It's about a 16% return.  How do we factor this into our long-term planning?

We'll have a mortgage in our new location, total annual spending of $43K (including mortgage) and investable assets at about 18x spending.  DW will continue to work part-time for a few years generating ~$25K per year while I start a small side-business.

Should the rental income take the place of bonds in our asset allocation?  Should DW be open to working longer?  Should I look for work in our new location?  Chances are we will be fine, but a series of unfavorable returns, or zero income in a side-business could put us at risk.  Home equity isn't going to pay our bills if the market decreases by 50%.

Factoring in appreciation to date, if we sold the original house and put the equity towards a less-expensive home in our new location - which we would continue to rent from my in-laws - we would be FI at a 4.1% annual drawdown (and not including wife's ongoing income).  But if we keep the house, in 15 years it will be paid off and generate more than 50% of our annual inflation-adjusted expenses.  I think the in-laws have put us in a position to cut years off our working life, but I'm not sure.  Input appreciated.

Spudd

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Re: Interest free home loan - are we FI?
« Reply #1 on: November 24, 2014, 01:54:48 PM »
I'm no real estate guru, but have you considered asking the folks if a similar deal would be available for your new house (I don't see why it wouldn't be, since they are OK with you renting out the old one)? If so, you could sell the old one, get the interest free loan on the new one, and be way closer to having everything paid off and incredibly low cash flow needs.

FrugalSpendthrift

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Re: Interest free home loan - are we FI?
« Reply #2 on: November 24, 2014, 02:52:38 PM »
We plan to move closer to the in-laws in 2016 for a low COL and small town environment for our school-aged kids.  We want to relocate before our oldest enters 1st grade, but I'm not 100% confident that we will be FI by then.  In-laws have already agreed to let us rent the house out.  We won't benefit from cash flow, but rent will generate ~$19K in equity each year (after expenses).   It's about a 16% return.  How do we factor this into our long-term planning?
So you are going to rent out a house that you don't technically own, and make payments on an interest free loan to your in-laws?  If the house is vacant for some period of time, are you going to still make the payments?  Are they relying on that income stream?  Is there any legal documentation for this asset transfer?  It would be a shame to lose all of that equity if their will doesn't reflect what they are telling you will happen.  Aren't they going to have a capital gains tax problem when they eventually give you the house?

And your other option is to tell the in-laws to sell the current house, buy a new one in some small town and you will now rent the new one from them (actually rent-to-own).  And they are going to hand over all of the home's appreciation?  It's nice that they don't want you to pay interest, but this seems like a convoluted way to transfer assets.  Are their other heirs in the picture that could complicate things? 

opnfld

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Re: Interest free home loan - are we FI?
« Reply #3 on: November 24, 2014, 05:10:54 PM »
I'm no real estate guru, but have you considered asking the folks if a similar deal would be available for your new house (I don't see why it wouldn't be, since they are OK with you renting out the old one)? If so, you could sell the old one, get the interest free loan on the new one, and be way closer to having everything paid off and incredibly low cash flow needs.
thanks, it's a good idea.  The challenge is that home prices in our new location are 70% of what they are in our current.  We'd have to move into a mansion or buy two houses (primary and a rental) to exempt the capital gains.  My FIL appreciates the current arrangement for its simplicity.

Also, I'm interested in keeping the current house for potential appreciation.  It's much more likely to appreciate than houses in our new location.

opnfld

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Re: Interest free home loan - are we FI?
« Reply #4 on: November 24, 2014, 05:21:37 PM »
We plan to move closer to the in-laws in 2016 for a low COL and small town environment for our school-aged kids.  We want to relocate before our oldest enters 1st grade, but I'm not 100% confident that we will be FI by then.  In-laws have already agreed to let us rent the house out.  We won't benefit from cash flow, but rent will generate ~$19K in equity each year (after expenses).   It's about a 16% return.  How do we factor this into our long-term planning?
So you are going to rent out a house that you don't technically own, and make payments on an interest free loan to your in-laws?  If the house is vacant for some period of time, are you going to still make the payments?  Are they relying on that income stream?  Is there any legal documentation for this asset transfer?  It would be a shame to lose all of that equity if their will doesn't reflect what they are telling you will happen.  Aren't they going to have a capital gains tax problem when they eventually give you the house?
That's right.  I understand what you are saying - it's a convoluted situation and I'm not sure how to weigh the risk. 
We'd make the payments if the house were vacant - just like a normal mortgage.  Vacancy in our area is incredibly low and we could sell if it made sense.  The house has appreciated 10-12% since purchased.
Capital gains won't be an issue for my FIL if he gifts us the house - he'll be subject to gift tax, but i think it will fall within the lifetime gift tax exemption.  The capital gains will be ours to deal with.

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And your other option is to tell the in-laws to sell the current house, buy a new one in some small town and you will now rent the new one from them (actually rent-to-own).  And they are going to hand over all of the home's appreciation?  It's nice that they don't want you to pay interest, but this seems like a convoluted way to transfer assets.  Are their other heirs in the picture that could complicate things?

FIL is generosity incarnate (and totally mustachian, although unaware of the concept) - he's making cash gifts to the only other heir until she's ready to buy a house.  I don't think there will be conflict.