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Investing in your offspring

By Jennie L. Phipps ·
Sunday, October 30, 2011
Posted: 6 am ET

Here's another good retirement planning strategy from Jonathan Bergman, who frequently offers  great ideas to this blog.

Bergman is a certified financial planner and vice president of Palisades Hudson Financial Group in Scarsdale, N.Y.

He says that with today's low returns on investments, it can be a win-win to lend money to adult children who want to buy a house or start a business. Your offspring gets a lower rate than he or she would from a commercial lender, and you make more return on your retirement nest egg than you would from a bank.

“The Bank of Mom and Dad can lend the money to the child at a low rate, using the home as collateral. Junior can borrow 100 percent of the purchase price without any need for mortgage insurance,” Bergman says.

Don't be overly casual about the transaction. Have a lawyer draw up a formal mortgage and promissory note, Bergman says. Make sure your offspring has adequate homeowner's insurance and agree in advance and put in writing what will happen if for some reason he defaults.

You can’t give your child too low an interest rate, or the IRS will consider the loan a gift. But rates are so low these days that even the federally designated minimum, known as the “Applicable Federal Rate,"  for November, 2011, is only 0.19 percent for terms less than three years, 1.20 percent for a three-to-nine-year loan and 2.64 percent for more than nine years.

To make this strategy work, you don't have to tie up your money for 30 years. The agreement can be for a much shorter term. At the end of that term, if things have been going well and you still don't need the cash, you can renew the loan. "The family profits instead of the bank,” Bergman says.

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John Q Taxpayer
October 31, 2011 at 11:35 am

Either Jennie doesn't work here anymore, or she's on vacation and bankrate is doing a "best of" week (best being relative, of course).

October 31, 2011 at 10:37 am

Never borrow money to family.

If they can't afford the house at the rock-bottom mortgage rates that are available, then they shouldn't buy the house.

October 31, 2011 at 8:44 am

This is completely assuming that "mom and dad" even have the money to loan out to junior in the first place, which in these days is tough to find.

And what happens when junior loses his job and gets late on payments?

Are you still making interest then? Still getting those payments? Sue the kid?

Let's rename the idea to: "How to make money off your kids."