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Together my wife and I have about $80,000 in student loans. My mother in law is in the process of selling her house. We proposed the idea of borrowing ~$50000 from her, once she sells, so that we could pay off our loans with higher rates. We offered to pay her back with an interest rate of 5%. Our idea was that we would be able to pay off all of the loans with a rate over 5%, and she would get a (nearly*) guaranteed 5% return rate.

Does this plan make sense to all parties involved?

Loan amounts and rates (from a couple of months ago, may update when I have more time):

$10,541.19      8.63%
$16,966.98      8.38%
$ 6,423.44      6.55%
$ 6,341.26      6.55%
$14,715.64      6.50%
$ 7,107.64      4.41%
$ 2,126.34      4.25%
$ 3,637.38      3.61%
$ 3,438.88      3.61%
$ 2,779.82      3.61%
$ 4,131.47      3.15%
$ 3,482.91      3.15%
$   697.95      3.15%

Some other relevant information:

  • We've already bought a house
  • We own both our vehicles (actually have a third we need to sell)
  • We're currently bringing in a little more each month than our monthly expenses, but can (and probably will) cut back in certain areas to have extra to pay off loans with even faster

* I only say nearly as you never know what could happen, but we have every intention of paying it all back at that rate.

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    Won't she need the money to buy a new house? – JTP - Apologise to Monica Jul 13 '17 at 19:37
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    This is the beginning of a tale of woe. Don't do it. Find a way to pay off this massive debt on your own. – Pete B. Jul 13 '17 at 19:37
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    You wouldn't be the first person to borrow from a relative. My only recommendation would be to ensure you formalize it with a contract. Not only does this make the terms explicit and easier to understand / adhere to, it's also important for your taxes so the IRS don't view it as a gift. – CactusCake Jul 13 '17 at 19:43
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    Did you already try to refinance those high rate loans? – Hart CO Jul 13 '17 at 20:42
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36

My biggest concern with this plan is that there's no going back should you decide that it is not going to work, either due to the strain on the relationship or for some other reason.

If you were borrowing from a relative in place of a mortgage or a car loan, you can always refinance, and might just pay a little more interest or closing costs from a bank. Student loans are effectively unsecured, so your only option for a "refinance" would be to get a personal, unsecured loan (or borrow against existing collateral if you have it). You are going to have a tough time getting another 50k unsecured personal loan at anywhere near student-loan rates.

The other negative aspects (overall risk of borrowing from family, loss of possible tax deduction) make this plan a no-go for me.

(I'm NOT saying that it's always a good idea to borrow from family for homes or cars, only that there's at least an exit plan should you both decide it was a bad idea).

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    Good points, if things go south and you were unable to make timely payments would that put strain on your MIL? Your lenders can approve a forbearance if such hardship should arise. – Hart CO Jul 13 '17 at 20:57
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    Definitely good points. – Ajschuit Jul 14 '17 at 1:11
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Personally, I avoid making business deals with friends and relatives. There's just too much of a possibility that things can go wrong.

Let's assume that you're honest people and you have no intention of cheating your mother-in-law. Still, all sorts of things could happen that could make it difficult for you to repay the loan. You could lose your job. You could get some big medical expense. Etc. Then what happens? Then your financial problems become family problems.

There's a strong temptation when people borrow from relatives to make paying the loan the lowest priority in their budget. "I know I promised to pay \$X per month, but things are really tight right now and Mom should understand." Maybe she does understand and can manage without it. But maybe not. And then it becomes a family fight. "You promised you'd pay it back." "And we will, we're having a hard time right now. Can't you just give us a break?" Etc. Or she might have some extra expense, and say, "Hey, can't you pay a little more this month? I really need some extra cash." "I'm sorry, we're struggling just to make the regular payments, we can't." "Well I was willing to loan you all this money. The least you could do is pay me back when I need it." Etc. You can end up ruining family relationships over money. Your wife can find herself in the position of having to choose whether to side with her mother or her husband. Etc.

I'm sure plenty of people do things like this and it works out just great. But there are big risks.

And by the way, apparently this was your idea, not your mother-in-laws. I wonder what her reaction is. Is she eager to help out her daughter and son-in-law and had nothing in particular to do with the money anyway? Or is she feeling very imposed on? It's one thing to ask relatives to let you borrow their car for the weekend. Asking someone to loan you $50,000 is a very big request. If one of my kids asked me to loan them $50,000 from my retirement fund, I'd consider that a very presumptuous request. (Unless they needed the money for life-saving surgery for my grandchild or some such.)

  • Good points here. It was my idea, but she has said she wants to be able to help us out. – Ajschuit Jul 14 '17 at 1:13
  • Wow! I never imagined how money in the family could go bad until somebody decided to stiff somebody, but you found some. – Joshua Jul 16 '17 at 21:53
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    It seems to me like the scenario where this is most likely to work is one where the mother-in-law is pretty comfortable and doesn't really need the money back on time. – Casey Jul 17 '17 at 14:57
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    @casey Yes. I heard advice years ago that has stuck with me: If you loan money to a relative, do it with the idea in your head that if you never get paid back, that's not a problem. My sister just asked to borrow $2,000 from me. (Obviously not the same scale as $50,000, but, etc.) I gave it to her with the thought that this is a gift, not a loan. I can afford that amount of money and I'm happy to do it to help my sister. I didn't bother asking for any repayment plan or anything. If she ever pays it back, great. – Jay Jul 18 '17 at 15:29
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I struggle to see the value to this risk from the standpoint of your mother-in-law. This is not a small amount of money for a single person to lend to a single person ignoring your personal relationship.

Right now, using a blended rate of about 8% and a 5 year payment period, your cost on that $50,000 is somewhere in the neighborhood of $11,000 with a monthly payment around $1,014. Using the same monthly payment but paying your MIL at 5% you'll complete the loan about 3.5 months sooner and save about $5,000, she will make about $6,000 in interest over 5 years against a $50,000 outlay.

Alternatively, you can just prioritize payments to the more expensive loans. It's difficult to work out a total cost comparison without your expected payoff timelines and amount(s) you're currently paying toward all the loans. I'm sure a couple hours with a couple of spreadsheets could yield a plan that would net you a savings substantially close to the $5,000 you'd save by risking your mother in law's money.

A lot of people think personal lending risk is about the relationship between the people involved, but there's more to it than that. It's not about you and your wife separating, it's not about the awkward dinner and conversations if you lose your job. Something might physically happen to you, you could become disabled or die. Right now, that's an extremely diversified and calculated risk taken by a gigantic lender.

Unless your mother in law is very wealthy, this is not nearly enough reward to assume this sort of risk (in my opinion). Her risk FAR outpaces your potential five year savings.

IF you wanted to pursue this as a means of paying interest to a family member rather than the bank, I'd only borrow an amount I budgeted and intended to pay within this single year. Say $10,000 against the highest interest loan.

  • Some fair points here. Good alternative, of a smaller amount that we could pay off sooner. I wouldn't say she is wealthy, but with selling the house and life insurance from losing FIL, she's in a position she would be able to help us out. – Ajschuit Jul 14 '17 at 1:18
  • Surely it's not primarily financial gain she would have in mind even entertaining this idea. – Casey Jul 17 '17 at 14:58
  • @Casey, it's not about financial gain, it's about the fully un-hedged high probability of financial loss. – quid Jul 17 '17 at 17:23
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I will start with the assumption that you will never have any late payments and will fully pay off the loan. This may be a big assumption, but if you can't assume that, then you wouldn't have asked the question in the first place.

The answer depends on your income:

  • If your combined income is great than $160K, then this is a win-win for both of you since none of your student loan interest is deductible anyway.
  • If you make less than $130K, then your student loan interest is fully deductible up to $2500 per year if the loan is qualified. In this case, a loan from a "related person" is not qualified, and therefore you could not take the deduction.
  • If you make between $130K and $160K, your student loan interest is partially deductible.

You should calculate how much student loan interest you can deduct before and after the switch, and adjust the interest rate accordingly to compensate for any difference.

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    The borrower would also lose any chance Loan Forgiveness due to Death, Disability, Public Service, Teaching or Low income that a typical Guaranteed Student Loan has. If the OP dies, would the wife be liable for his loans to the relatives? – Hannover Fist Jul 13 '17 at 21:53
  • Good points. I think our total payments on loans last year was something like ~10K so I don't think this would prevent us from taking the deduction. – Ajschuit Jul 14 '17 at 1:20
  • @Hannover Good point there, too. In this case she would be liable for the loans as they are mostly hers to begin with. Mine would be covered by my life insurance policy. – Ajschuit Jul 14 '17 at 1:37
  • @Ajschuit - note it isn't the total payments, it's the total interest payments. You'll want to look at the interest paid per loan based on the end of year statements. It's likely the case that the $30K remaining lower interest rate loans will total less than the $2500 you can probably deduct today. – TTT Jul 14 '17 at 14:44
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I have recently been the lender to a couple people. It was substantially less money (~$3k), but I was trusting their good faith to pay me back. As a lender, I will never do it again.

Reasons,

  1. Even with interest, I can make more in my typical investment routine than I was receiving from them
  2. As a lender, you have to figure out how to convince people to pay you without making them upset.
  3. I've noticed that the people asking me for money tend to be those that can't or don't want to get it from other places like banks. This ought to be a red flag for any lender.

Overall, not worth it.

1

"Would it make sense to take a loan from a relative..." Other people have pointed this out, but honestly, I'd be very reluctant to answer "yes" to this no matter how you completed that sentence. There's always an intangible risk to mixing money and relationships. There's a lot that can go wrong during the duration of the loan, and if it does, the consequences could be a lot greater than just a bad credit score.

  • I agree with the advice not to borrow money from family or friends, but I'd put it into slightly different terms. From the viewpoint of the lender, if you give money to relatives consider it a gift. Perhaps you might get it back, fine, then you can give it to other relatives in turn. But don't hand the money out if you are not truly prepared to write it off completely. – o.m. Jul 16 '17 at 15:24
0

The interest that you are proposing to pay your MIL is actually quite low compared to even extremely conservative investing which easily earns 7% or more with quantifiable low risk. You claim that it would be no risk, but what would happen if you lost your job? The risk she faces is more or less exactly what a bank would experience while giving the loan, or in other words it is pretty much whatever your credit score says. Even worse, she does not have a large pool of investments to distribute this risk like a bank would.

Making loans this large in a family situation is a recipe for disaster. Taking a huge risk with the relationship your wife has with her mother over three points of interest is exceptionally unwise.

Are these private or federal student loans? Federal student loan debt is some of the safest to carry due to its income based repayment plans and eventual loan forgiveness after 25 years. Have you investigated income based repayment options?

protected by Community Nov 23 '17 at 21:07

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