Dear Dr. Don,
I'm wondering whether we might be able to keep some financial business within the family. My mother just retired at age 71 with a nest egg of $200,000. As for myself, I have a mortgage that will be paid off in four years with a current balance of $56,000.
I have asked my mother whether she'd pay off my home loan. In return, I'd pay her 4.75 percent in interest as well as principal each month for the next four years. I'd rather that she get the money instead of the bank. What tax implications could this have on both ends?
-- MB Mortgagor
Ah, mom, apple pie and mortgages!
Structured properly, a private mortgage isn't a gift. The interest rate of 4.75 percent for a loan of up to five years is certainly above the applicable federal rate, so there's no gift in the form of a below-market interest rate. If the loan is secured by the home, then you can utilize the mortgage interest deduction. Your mother would have to pay income tax on the interest income.
Is this the right move for your mother? Loaning you $56,000 would require more than 25 percent of her retirement nest egg invested in the home loan. Assuming that you are a good credit risk, earning 4.75 percent on that money beats what she can get in certificates of deposit or other low-risk investments.
I assume if you would be willing to pay a higher rate of interest than what the market would require, refinancing doesn't make sense for you. Maybe that's because of your loan balance and your desire to pay off the loan in four years.
Mom will have to decide whether she wants to work with a real estate attorney or try a website to draft the mortgage or deed of trust on the property and the loan documents. That's, of course, if she wants to move ahead.
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