Good idea? Bad idea? Investing LoC in relative's mortgage

[HammerRFDer]

Ok, so hear me out entirely here.

I have a close relative with a mortgage fixed at 5.9X% interest rate with prepayment privileges. The loan still has a couple years to go before being refinanced again, and it was determined that the savings from having to break it to switch to a variable wasn't enough to cover the costs and risks of switching to a variable rate.

I have been approved for an unsecured line of credit for a rather substantial amount of money at bank prime rate + 0.25% (For a total of 5% these days). They gave me wayyyy more than I'll need.

I have no issues with trust or credit with this individual. Just assume that they are 100% trustable for this situation. They are an _excellent_ credit risk, but probably couldn't pay back the whole amount "on-call".

How can I structure this so that the interest received on the loan I make out counts against the LoC interest for income tax purposes? Is there any way that I can use this LoC for both personal use and lending-out without losing this tax strategy?

Are there any real risks with this, other than the interest rate rising and not being able to pay it back instantly? (A small loss is stomachable, and I don't think rates would drastically go up by >1% too quickly).

Any opinions?

(Please, no "don't lend to family" responses, unless you have seriously good reasons to suggest that)

[jerryhung]

At prime + 0.25% I wouldn't do it
If you get 0% Balance Transfer from CC's (see RFD threads, technically cost is 1%), then definitely yes.

[HammerRFDer]

I likely wouldn't qualify for remotely-high-limit BT credit cards. I'll try and see, but the time it takes to get them and such, then requesting increases etc (and the fact that you need to watch them like a hawk) isn't quite appealing to me at this point.

Maybe in January...

[Wonderdollar]

Ok, so hear me out entirely here.

I have a close relative with a mortgage fixed at 5.9X% interest rate with prepayment privileges. The loan still has a couple years to go before being refinanced again, and it was determined that the savings from having to break it to switch to a variable wasn't enough to cover the costs and risks of switching to a variable rate.

If you could post here information such as, the name of the lender, the original mortgage amount, the remaining mortgage amount, the exact remaining term (in months) and the prepayment privilege amount your relative is allowed to pay, then may be we can suggest a better alternative then being thought of by you.

The reason for this is that we would know what products and the present mortgage rates are being offered by that particular lender which could be used to get a better result. Some banks like Scotia does allow you a 'peeling off' which can be used for lessening the interest burden or if your relative has equity available then he/she can secure a LOC and use the same for pre payment and reduce the burden him/herself. Hence, your relative's lender may be offering such facility etc. which would be a better alternative.




I have been approved for an unsecured line of credit for a rather substantial amount of money at bank prime rate + 0.25% (For a total of 5% these days). They gave me wayyyy more than I'll need.

It seems that you have a good credit and stable income which helped you get this unsecured LOC. Good for you.


I have no issues with trust or credit with this individual. Just assume that they are 100% trust able for this situation. They are an _excellent_ credit risk, but probably couldn't pay back the whole amount "on-call".

That is one issue that your relative would not be able to pay 100% amount on-call which may become a huge issue in future as no one knows about the future.


How can I structure this so that the interest received on the loan I make out counts against the LoC interest for income tax purposes? Is there any way that I can use this LoC for both personal use and lending-out without losing this tax strategy?

You can not use this LOC for getting any tax deduction as you are not using the LOC for investment purpose. Moreover, no one should ever mix the usage of same LOC for investment and personal purposes as it is a definite recipe for an audit by the CRA at some point in future if not immediately.



Are there any real risks with this, other than the interest rate rising and not being able to pay it back instantly? (A small loss is stomach able, and I don't think rates would drastically go up by >1% too quickly).

Any opinions?

(Please, no "don't lend to family" responses, unless you have seriously good reasons to suggest that)

The biggest risks involved could be a loss of income for any of the 'dreaded reasons' (For which you generally need various types of insurance such as critical illness, disability and life) or simply a job loss due to restructuring or weakening economy etc. and their excellent risk status may turn out to be not so good and then it is your liability to pay your LOC interest so as NOT TO spoil your good credit.

[HammerRFDer]

Looks like the investment loan stuff would be a PITA, even if lending it out and generating interest does make the LoC interest tax deductible against the income. Especially since the paper-trail isn't too concrete.

Not sure why the rule is so strict on using it for investment loans only, but I guess that's the way it is. And I wouldn't be able to split the LoC to two loans either.

[epson600]

So you can borrow at 5% and his loan is 5.9%. If we split the difference that means that this scheme will save him 0.45% and you will make 0.45% (IF your 5% loan is deductible). On $100,000 loan that would be $450 a year. Less taxes (assuming 37k-63k 31.15%) leaves you with $309 profit. Even if the loan is completely guaranteed no matter what it seems to be a lot of hassle for very little return and I assumed deductibility of your interest which I would not take for granted.

If you were to suggest taking out a loan and purchasing shares of a canadian bank that is yielding ~6% right now would make more sense that this. Your interest payments are deductible, you would only be taxed 7.52% for the CDN dividends instead of the 31.15% for Interest income, and you would make 1% ($924 after taxes) of profit. And since you said it wouldn't really matter if they "couldn't pay back the whole amount "on-call" then you probably can afford to wait a couple of years if the stock continues to do poorly in the short term.

PS: I forgot to take into account that your interest deduction on your 5000 loan is at your marginal rate 31.15% while the tax on the 5000 used to pay the interest is only 7.52%. In addition to the above profit you would also save 31.15-7.52%=23.63% in taxes on the 5000$, around ~$1180.

You would end up with around $2100 in your pocket on your investment of $100,000 so a 2.1% return versus 0.31% on your mortgage plan. Actually if the interest on the mortgage plan is not deductible then you end up loosing $1248 so the return would be negative 1.25%.

Wow, thats a long post and I had a long day so I probably made a mistake somewhere but you get the idea.

PS: Whoops. I am not advocating taking out 100k and putting it into one stock. Its just an example

[Phoenix88]

To me it doesn't sound like the OP wants to make money off this but rather assist a family member in getting a lower rate. I am sort of under the same boat but the mortgage holder.

Tax purposes, if you lend money to someone and have them pay the interest then you don't really need to report anything since the interest income is washed with the carrying charge (atleast I wouldn't bother and this is how we do it for our clients). If you are making a bit of money above what you have to pay for the interest then record that as interest income or record both the total interest you recieve and the carrying charges. Or if you want just hide it because it is from a relative and you trust him and no one will ever know any different if you recieve an extra $50 a month.

What I would do in this situation is ask him if he/she wants to pay down some of his mortgage... write him/her a cheque and get him/her to take out a HELOC against the portion you put down. This is assuming that he/she has equity in the property already (hopefully people don't pay that dreaded CMHC).

So if he has 200,000 mortgage 40,000 in equity (240,000 FMV property).

Chip in 20% of his mortgage, 40,000. He/she should be able to borrow 40,000 and pay you right back (or whatever he is comfortable with Variable Prime+nil).

Now I am not sure if this works, but I don't see any reason why it wouldn't. He has the loan in his name, you helped him out. And now he is recieving 40,000 of his mortage at Prime. 1% savings? 400 a year? Only worth it if he wants to convert some of his mortgage into a revolving line of credit. There may also be fees to open the HELOC. And every little bit counts. 400 x 5 years = 2000 = trip somewhere nice. Plus he can plug away at the HELOC whenever.

Hope this advise is correct, I am specialize in accounting not finance.