Thursday, March 5, 2009

My Father-in-law is my Master

Three times in the last two weeks I’ve encountered people engaged in or preparing to engage in lending money to family. All three cases are the same: parents wanting to help their kids financially are lending money at a lower interest rate than the kids could get from a bank on their mortgage. Financially, it all looks like a good deal: the parents get some guaranteed return on their money better than most Certificates of Deposit are offering now and the kids have lower mortgage payments.

One of the cases I’ve encountered resulted in the parents, daughter, and son-in-law sitting around a table in my office, the two kids in tears. Yikes! What looked great on paper resulted in an incredibly burdened relationship when unexpected events derailed the “good deal.”

The very first debt myth I cover in our Past Due Boot Camp is “lending money to a family member or a friend is wise because I’m helping them.” The truth comes from a trustworthy source: the Bible. Proverbs 22:7 – “the rich rule over the poor and the borrower is slave to the lender” – packs a lot of punch. In practice, if you have the means to help someone financially just give them the money and don’t expect it back. Let it be a gift instead of a loan because no one likes eating Thanksgiving dinner with their master.

Two weeks ago a friend in a position to pay off her daughter and son-in-law’s mortgage (and then replace it with a lower interest loan to her and her husband) asked me if I thought it was a good idea. The kids get a lower payment and the parents make a better return than they could get at the bank; seems like a win-win. After I cited the Proverb, I told her she asked the wrong financial guy if she was looking for affirmation. She is financially savvy, and so I think it important to address the financial merits of such an endeavor along with the relational.

Let’s say that the mortgage currently has an outstanding balance of $200,000 and the couple has an interest rate of 6%. If they’ve been in the house for a year already, there are 29 years left to repay. The parents propose an interest rate of 4%. On paper everything looks like a great deal. The mortgage payment goes down by $227.15 each month; the total saved on interest and principal is just over $93,000 during those 29 years. The parents’ $200,000 investment becomes $338,000 when the mortgage pays off.

Let’s put ourselves in the shoes of the parents. Would it really be wise to tie up $200,000 for 29 years in an investment yielding a whopping 4%? Sure, we look around at the current market conditions and a 4% return seems like 40%. But in the next five years, the likelihood is that the market will turn around. We could even make the argument that investing $200,000 today – when the stock market is deeply discounted – could make these parents at least $381,000 more than the mortgage option during the same amount of time.

So, financially, it doesn’t appear that tying up those assets for so long is an ideal option for the parents. However, if you asked them, they’d probably say they just want to help their kids out. What if the kids sell the house three years into their deal? That’s a lot of lost interest. What happens if, six years from now, the son-in-law loses his job? What if he becomes disabled and doesn’t have disability insurance? What if…? What if…? What if…? Could any of these life changes leave a sour taste in one or both parties’ mouth? Basically, have these parents considered all the relational pitfalls of this financial deal? They could wind up holding a mortgage for kids who can’t repay and relationally they would become their children’s masters.

Why disrupt a great parent-child relationship or strain a daughter’s marriage in the name of 2% lower interest? I’m sure we all can think of examples in our own lives where what looked great on paper didn’t unfold according to plan. Placing a higher value on relationships than the almighty dollar will help us all keep the big-picture perspective we need when mixing family and finances.

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