Author Topic: Should we take an inter-family loan to pay off our student debt?  (Read 5769 times)

Dezrah

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Thank you in advance to anyone who takes the time to read and contribute to the discussion.  Your thoughts will not fall on deaf ears.

My husband graduated law school with about $61k in student loans at 6.55%.  Since then, he got a great job for our area and we have been aggressively paying down the balance.  We are now down to about $43k principal.  I’ve layed out (and yes, this is proper, if archaic grammar) a challenging but realistic plan that would have the remaining balance paid off by 7/31/2015. 

A wealthy relative has offered to loan us a personal loan at 2% to pay off the full amount.  When I compare the two scenarios, I find that accepting her offer will save us about $1,020 versus continuing our current plan (this does account for differences in tax deduction).  I also like the idea that she will be getting the interest instead of the loan company.

There are a few other non-tangible downsides to accepting her offer:
-Carrying the loan with a company is building a long history of good credit which will come in handy since we want to buy a house in the next 1-3 years.
-Paying ahead as much as we have has pushed out our next official “payment due date” by about 22 months.  This means we could completely stop payments for that amount of time without accruing fees (interest would still accrue as normal).  Accepting a personal loan would effectively wipe out this potential cash flow cushion.
-Making personal payments several times a month will be less convenient than the quick and easy online payments we currently make.
-We will need to keep very careful records to keep everything square in the eyes of the law.
-We are both proud that we have been completely independent of financial assistance from our families for a long time now and mixing family and money at this point could have an unanticipated effect on various relationships.

So this is my question, what do you guys think?  Is $1k worth it or should we just keep going as we are?

Paul der Krake

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Re: Should we take an inter-family loan to pay off our student debt?
« Reply #1 on: January 13, 2014, 11:42:29 AM »
-We will need to keep very careful records to keep everything square in the eyes of the law.
In that scenario, and assuming you are in the United States, wouldn't the proposed plan run afoul of gift tax because of the large amount? That could get you in the IRS's crosshair really fast if you are not careful.

Additionally, what would paying interest to your relative mean in terms of family dynamics? Rationality and family don't always mix well (if at all).

MooseOutFront

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Re: Should we take an inter-family loan to pay off our student debt?
« Reply #2 on: January 13, 2014, 11:46:17 AM »
It sounds like you have carefully ran the numbers and, to me, a $1,000 savings is not worth it at all.

If, otoh, your plan was to keep the loan as a pet and your wealthy relative was cool with keeping the same long amortization schedule it currently has, then I would rather invest in the market than pay down a 2% non tax deductible loan any day of the week.

MissStache

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Re: Should we take an inter-family loan to pay off our student debt?
« Reply #3 on: January 13, 2014, 11:49:24 AM »
I wouldn't do it.  $1000 isn't enough to offset the convenience of online payments and the 22 month buffer you have built.  Plus, it can make things weird with money and family.

And the pride you get from doing it on your own is priceless!

simonsez

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Re: Should we take an inter-family loan to pay off our student debt?
« Reply #4 on: January 13, 2014, 12:00:37 PM »
If the relative offered you this deal initially rather than some begging on your end, then I wouldn't be too worried about family awkwardness.  A cool $1,000 is nothing to sneeze at where I come from and like the OP said, I like the interest going to a family member rather than an unrelated company.

As for the gift amount, it is $14,000 per year I believe.  At minimum, I would ask for $14,000 each January from the relative, pay a 2% load immediately on that to the relative, and then plop the remaining down on the loans yourself.  You'd have to workout a repayment schedule with the relative and still make minimum payments (on the graduated & extended plan if possible to reduce the minimums). That way, you don't break any gift laws, your relative is getting something out of it, and your credit will continue to build.  Only downside is that your loans will exist for longer than if you were to zap them all at once, obviously.

Any loan arbitrage you do I would view as getting it done on your own and something to be proud of, regardless of who recognizes that deed.

the fixer

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Re: Should we take an inter-family loan to pay off our student debt?
« Reply #5 on: January 13, 2014, 12:24:29 PM »
I've seen family loans get awkward, where the lender feels bad about charging interest and doesn't want to accept it. I've also seen a family loan offer that had a lot more promise because this one's lender was rationally comparing the interest he'd get from the loan versus from his bank account where the money was.

So I think it will work as long as you have the following:
  • Lender and borrower (you) are treating the situation as rational investors looking to maximize each's own financial outcome, while realizing that this situation is best for both sides
  • Confidence on both sides that there is NO default risk
If you haven't already, you should consult an accountant or other tax expert. I wouldn't take the above claims at face value that this is subject to gift taxes. It sounds to me like it's a loan, not a gift, and the only part that's taxable is the interest the lender receives from each payment. But I don't know anything about this aspect of taxes, so don't take my word for it either.

Dezrah

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Re: Should we take an inter-family loan to pay off our student debt?
« Reply #6 on: January 13, 2014, 02:01:12 PM »
In order for this to be considered a non-gift loan by the IRS, it is necessary to charge a minimum interest rate that is connected to the prime interest rate and the term of the loan.  This website does a really good job explaining it.

http://www.nationalfamilymortgage.com/afr-rates/

If we did this, we'd go with a 2% loan with a 5 year term.  We would draw up a formal contract that spelled out all the terms, including late payment fees, structure for defaulting, extra payment calculation, etc.  There are even templates you can purchase online for about $10 that guarantee to meet all the relevant federal and state conditions for legal loans.  On top of all that, the lender would also have to report the interest portion of our payments as income when she filed her taxes.

On the personal side, this was something she freely offered unsolicited by us.  However, I think part of the motivation for making this offer stems from the fact that there are numerous relatives among our circle who have a dysfunctional relationship with money.  There seems to be this undercurrent of belief that all money is family money regardless of who earned it.  This is not a belief we share and I cannot help but worry that accepting an offer could in some ways entangle us in this dynamic.  I am almost certainly making this more ominous than it actually is.

Tackling these loans on our own would make us very proud, but pride is a vice too.  As simonsez pointed out, a $1,000 is not an insignificant amount of money.  Not everyone gets the chance we have now.  The last thing I'd want to do is make an obviously nonsensical decision just because it's the "proud" choice.

As it is, I'm still getting the vibes that there's really not an overwhelmingly right choice, so I'll probably go with my gut and my husband's preferred choice and not accept the loan.

(I'd also like to apologize for such an overly flowery post.  I read a lot of Jane Austen this weekend and I think it's starting to mess with my head.)

MissStache

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Re: Should we take an inter-family loan to pay off our student debt?
« Reply #7 on: January 13, 2014, 02:23:48 PM »
(I'd also like to apologize for such an overly flowery post.  I read a lot of Jane Austen this weekend and I think it's starting to mess with my head.)

It is a truth universally acknowledged that relative in possession of a fortune will field off requests from entitled and indebted relations who need bail-out money. 

YOU are clearly not that relation.  I think Jane would be proud!

Thegoblinchief

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Re: Should we take an inter-family loan to pay off our student debt?
« Reply #8 on: January 13, 2014, 02:30:26 PM »
You could really go either way. Personally I would decline the loan, since I'm terrible at remembering to mail checks versus doing online payments.

Insanity

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Re: Should we take an inter-family loan to pay off our student debt?
« Reply #9 on: January 13, 2014, 02:40:25 PM »
My understanding is that it is the lender's responsibility to worry about the gift tax, not the borrower.

Cheddar Stacker

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Re: Should we take an inter-family loan to pay off our student debt?
« Reply #10 on: January 13, 2014, 03:34:06 PM »
This is not a gift unless they really screw it up.

However, just to clarify the IRS gift rules for those speculating (or interested for whatever reason) - If you give a gift, as the giver you are responsible for filing a gift tax return and paying the appropriate gift tax. However, you can gift up to $14K/yr/person. So a married couple can give another married couple $56K/yr without filing a gift return or paying a gift tax.

In addition to that you have a lifetime gift/estate exemption of $5M + you can apply any gift towards. If you're going to do that, file a gift return, but you don't pay any taxes.

Cheddar Stacker

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Re: Should we take an inter-family loan to pay off our student debt?
« Reply #11 on: January 13, 2014, 03:39:27 PM »
And for what it's worth, I would take the loan and invest the calculated savings somewhere (segregated from other accounts) for future use. This could be the start of your future child's college fund, or your around the world trip fund. Wouldn't it be great if your child didn't have a student loan because great aunt Betsy gave us this loan and we invested the savings.

What a great legacy for the relative to leave behind. If she did this for the entire family, and they all saved it properly, she could fund the whole next generations college education.

This is the type of legacy I'd like to leave behind for my family if possible, and hopefully FIRE is something that will allow this to happen.

frugaldrummer

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Re: Should we take an inter-family loan to pay off our student debt?
« Reply #12 on: January 13, 2014, 03:55:40 PM »
For just $1,000 difference, I wouldn't get entangled in family loans.

Megatron

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Re: Should we take an inter-family loan to pay off our student debt?
« Reply #13 on: January 13, 2014, 04:07:05 PM »
I would not do it. My parents have been entangled with the whole inter-family loan scene before. It was not pretty. Family and  Friendship dynamics changes when money is involved.

AlanStache

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Re: Should we take an inter-family loan to pay off our student debt?
« Reply #14 on: January 13, 2014, 04:08:21 PM »
Quote
There seems to be this undercurrent of belief that all money is family money regardless of who earned it.

Having it become expected that you will make a similar offer to the next generation (perhaps before they graduate) could be awkward.  "Well Uncle Bill paid off your loans for you so why cant you loan me something?"-Not a good situation.

If you decline the loan, perhaps a small thank you gift to your relative would be appropriate to let them know you really did appreciate the offer but it just was not right for you two.

Edit: But yeah I would lean away from the loan too.  1k$ does not seem worth the extra work and potential for family issues.
« Last Edit: January 13, 2014, 04:10:57 PM by AlanStache »

mlipps

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Re: Should we take an inter-family loan to pay off our student debt?
« Reply #15 on: January 13, 2014, 05:20:17 PM »
As long as your bank has free bill pay, you can use that to send no hassle checks to your relative. I did this to pay my mom back for a small loan and also do it to pray my landlord every month. Whether she will find if annoying to cash several checks a month could be a different story.

Dezrah

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Re: Should we take an inter-family loan to pay off our student debt?
« Reply #16 on: January 14, 2014, 04:46:54 PM »
Thanks again to everyone for weighing in.

For what it's worth, if this were a bank making me a 2% loan offer, I would take that in a heartbeat and leverage the difference toward investments or a down-payment on a house.  This really is just about the unknowable cost of mixing family and money. 

Alternatively, I think I would feel okay accepting a loan offer if we were going through a crisis where we were running a deficit each month.  This would be exclusively as a short term fix though, and it's actually comforting to know that level of safety net is there if we truly needed it.