Save Thousands by Refinancing Your Loan, But Not With a Bank!

Do you have a car or home loan? You might be able to get a much lower interest rate than any advertised rate, potentially saving you thousands of dollars! The secret is: don’t use a bank for the loan!

I got this idea from my parents, who are retired and looking for somewhere to put their savings. With banks offering next to nothing for interest rates (a fraction of a percent), and the stock market so volatile, they were looking for somewhere to stash their retirement savings.

At the same time, I had a 30-year loan on my condo for over $100,000 at a whopping 5.2% annual interest rate.

The solution for both of us was to dump the bank and have my parents loan me the money! It’s a total win-win, with them getting a much higher interest rate from me than any bank can offer, and me getting a much lower interest rate for my loan from them. In addition, I’d much rather pay the interest to my parents than a bank!

We agreed on an interest rate of 2.6%. This will save me over $3,000 this year alone. Since I also shortened the loan, this scheme will save me literally tens of thousands of dollars over the course of the loan that I would have paid to a bank. They win big too, because 2.6% is a lot better than 0.5%!!

Make Sure You’re Good For the Money

Now, there are a few caveats here. First, if you take a loan from a family member, you better make sure you can pay it off. I mean, you should do that for any loan, but in my example, I am holding my parents’ retirement money in my hands. While defaulting on a bank is very bad, defaulting on a relative is worse in many ways.

Use the Right Interest Rate (Applicable Federal Rate)

Second, you need to choose a reasonable interest rate. Pick too low, and there could be some very unpleasant tax implications. For this reason, do not do a zero-interest loan! Picking too high might actually violate the law (it’s called usury), but since the whole point is to pick low, there is little danger of that.

The IRS defines what is called the Applicable Federal Rate (AFR) for short-term (three years or fewer), mid-term (3-9 years), and long-term(over 9 years):
http://apps.irs.gov/app/picklist/list/federalRates.html

These rates are adjusted every month. If you charge at least these rates, you can avoid federal income tax and gift tax headaches.

Since much of this is tax-speak (and I am not an accountant), you should consult with your accountant to insure you’re using the correct interest rate.

Draw Up a Promissory Note

Third, you’ll need your accountant or lawyer to draw up the paperwork (it is called a promissory note). It’s not difficult. Don’t do a verbal agreement or just jot something down on the back of a napkin for this! Treat it like a real contract, even though it’s with a loved one.

Yes, there is some cost to get an accountant, but it’s a fraction of the cost of re-financing with a bank, and an even smaller fraction of what you’ll be saving just in the first year in most cases.

Secure the Loan Against the Home

Finally, if the loan is for a home, you’ll need to secure the loan against the property so that you can deduct the interest at tax time. You’ll need to get a lawyer or at least a paralegal to draw up a deed of trust. This serves as official documentation that the loan is for the home. It costs about $500 but it’s pretty easy. I know this sounds like a pain, and a lot of expense, but it is well worth the money and effort since it allows you to deduct the interest!

I am not a lawyer or an accountant, so please consult a professional before doing this.  Let me know your experiences and tips about this idea! – Brian