# Family mortgage or Investment?



## dosvog2002 (Feb 22, 2015)

Hi all
I wonder if someone could make sense of some numbers for me?

Our family has recently come across a situation that to me seems to be unfair for one of the family members. My MIL has lent her life savings to my sister-in-law to buy a house, with the deal being that she is paid back as per a mortgage arrangement. So, my MIL is effectively acting as a bank to my sister-in-law. 
However, my wife and I are not sure whether this is the best thing for her to do with her money.

So, rather than get into a discussion on the potential problems associated with lending money to family, I'd like to look at the raw numbers of this mortgage arrangement and compare it to other forms of investment. I also don't want to get into a discussion concerning inflation rates and the future value. At least not yet.

A quick look at the numbers:
Loan: $300000
Interest Rate: 2.5%
Amortization period: 25 years

My calculations suggest that after this mortgage is done, my MIL will be paid $103755.06 in interest.
If I divide this figure by the years in the loan, this equates to $4150.20 interest per year, or 1.38%. Although it might not be a technical term, but I view this as a downward compounding investment. 

My first question is: Is it fair to view this loan as paying 1.38% interest per year?


I would like to compare the above data with some other scenarios.

Say my MIL invested her money in a different investment that pays 2.5% interest per year. I calculate the interest earned if my MIL just took cash each year (not reinvested) from her $300000, she would earn ($300000 * 2.5%)*25 years = $187000


Furthermore, if she invested her money at 2.5% and it compounded each year, I calculate that she'll earn $256183.23


My Second question is: Are the above scenarios correct? Is it the case that through her loan to my sister-in-law she is earning $103755, whereas if she started a compound interest investment, she gain $256183?

I am worried that I'm missing something here, and because this is a delicate intra-family loan. i certainly don't want to approach my sister-in-law with incorrect information.

Many thanks for your time

Phil


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## Davis (Nov 11, 2014)

If the loan is being structured as a mortgage, then sister-in-law will be paying principal each year in addition to interest, so every year the amount of the loan outstanding is being reduced. That is why the interest being paid is less than 2.5% of the original loan. For example, by Year 10, lett's say that sister-in-law has paid off $100,000 of the principal. She would then be paying 2.5% interest on $200,000, not on $300,000. 

The comparison to a compound interest loan with no principal repayment is not valid. 

If you mother-in-law is in an accumulation phase, the principal repayment is inconvenient for her: she has to reinvest those amounts each year. But if she is living off her investments, then she may want the extra money coming in - she gets to burn off her capital.

I would only be concerned about the *term* of the mortgage. How long is the 2.5% interest set for? Sister-in-law can probably find a 2.5% mortgage elsewhere, but the rate would only be set for 2-3 years. After that she would have to renegotiate at a higher rate. Setting that rate for 25 years is probably a bad deal for mom, unless she is happy with the income she is getting, and wants to help out her daughter, which is as perfectly valid financial planning decision for a parent.


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## gt_23 (Jan 18, 2014)

dosvog2002 said:


> My first question is: Is it fair to view this loan as paying 1.38% interest per year?


No it's not. Amortizing loan balances get paid down with each payment, so every subsequent payment's interest is based on the balance owing, which goes down. She will earn 2.5% of the balance of the loan over the period, not the principal amount of $300k. The funds that come back as principal repayments can be reinvested elsewhere to get the full 2.5% on the total $300k.



dosvog2002 said:


> My Second question is: Are the above scenarios correct? Is it the case that through her loan to my sister-in-law she is earning $103755, whereas if she started a compound interest investment, she gain $256183?


Sure GICS and savings accounts compound more frequently, but at 2.5% its not likely to make a big difference since most mortgages don't go on for 25 year. What you need to find out is the term of the loan (when it comes due), since your mother can reset the interest rate at that time. If interest rates continue to decrease, then the second scenario might actually be worse. Don't plan a mortgage investment based on the Am period, plan it based on the term. Any number of things will happen to make your projected numbers irrelevant.


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## OptsyEagle (Nov 29, 2009)

dosvog2002 said:


> My Second question is: Are the above scenarios correct? Is it the case that through her loan to my sister-in-law she is earning $103755, whereas if she started a compound interest investment, she gain $256183?
> 
> I am worried that I'm missing something here


If your MIL re-invests the monthly payments she receives from your SIL, at 2.5%, she will end up very close to the $256,183 number you are aiming at (I am assuming you did the math correctly).

So what you are missing is the reinvestment of the monthly payments by your MIL.


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## Just a Guy (Mar 27, 2012)

dosvog2002 said:


> Hi all
> I wonder if someone could make sense of some numbers for me?
> 
> Our family has recently come across a situation that to me seems to be unfair for one of the family members. My MIL has lent her life savings to my sister-in-law to buy a house, with the deal being that she is paid back as per a mortgage arrangement. So, my MIL is effectively acting as a bank to my sister-in-law.
> ...


Okay, first off, note the bolded part. It's her money. That should be your first clue to stay out of it. 

She is investing it in a secured asset, paying a return a lot higher than money sitting in a bank. 

Is it the best investment, not by any chance, but it's better than a lot of others and, despite the fact that you are unhappy, your MIL seems to be doing things properly with *her money*. I assume she'll register the loan against the title, if not that would be a good suggestion. 

It sounds to me like you're more worried about getting an inheritance, or that your SIL is "benefiting", more than you and your wife. 

Once again, refer to the bolded part of your quote. 

Now, you are entitled to be concerned, you're entitled to have an opinion, but you are not entitled to the money and *they* are entitled to having you keep the first two to yourself after you've expressed it once, if that.


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## birdman (Feb 12, 2013)

I agree with the comments by others and emphasize that the mortgage have a specific term eg 1 yr, 3 yr, 5 yr, etc and at that time the mortgage is due in full. Normally, they can be renewed but at the prevailing interest rate. Locking in a rate of 2.5% for 25 yrs isn't very good if rates go up to 6% or? Also, I would ensure the mortgage is done by a lawyer, vetted by your MIL's lawyer, and registered in the Land Titles Office.. If its all done properly and above board the investment would probably be ok but so often these things seem to go sideways. With our children, whatever we do for one we do for the other. One further thought, is what % of your MIL's portfolio would the mortgage be? If it was 10% it wouldn't be bad but if it was 90% thats a different thing as it would take away from her portfilio diversification. Also remember that the interest income is taxable.


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## dosvog2002 (Feb 22, 2015)

Just a Guy said:


> Okay, first off, note the bolded part. It's her money. That should be your first clue to stay out of it.
> 
> She is investing it in a secured asset, paying a return a lot higher than money sitting in a bank.
> 
> ...


OK, As I stated in my original post, the purpose of my inquiry is to determine the viability of the loan as an investment, not to weigh the pros and cons of family investment. Please respect that, and don't make any inferences based on what you read and judge our motives. FYI my MIL is unable to look after her money because of mental illness, and therefore my goals are to ensure that she is comfortable in her retirement. Also, my wife and I are quite comfortable with our money and are not interested in any inheritance. 

To all others who have posted - Thanks so much for your input. I'm working on a big project today, so was planning on replying this evening, but I just wanted to quell any further suggestions as to our motives.


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## Rusty O'Toole (Feb 1, 2012)

Could the SIL go to the bank and get the same loan on the same property? If so it is a good deal for your MIL. The only way it would be a sweetheart deal is if the borrower or the property would not qualify for such a low rate. In that case the lender should get the market rate.


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## dosvog2002 (Feb 22, 2015)

frase said:


> One further thought, is what % of your MIL's portfolio would the mortgage be? If it was 10% it wouldn't be bad but if it was 90% thats a different thing as it would take away from her portfilio diversification. Also remember that the interest income is taxable.


It's 100% of her money. Which is obviously a major concern of ours and on the agenda when we discuss this with the family.


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## Just a Guy (Mar 27, 2012)

dosvog2002 said:


> FYI my MIL is unable to look after her money because of mental illness, and therefore my goals are to ensure that she is comfortable in her retirement.


Are you, or does she have, a power of attorney? If not, then you have no grounds unless you want to declare her mentally incompetent. If your SIL is the power of attorney, then you'd need to prove this is an bad investment, which, as most people said including myself judging from the information you gave, it isn't. The only things mostly suggested is to ensure there is a proper, registered agreement.


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## birdman (Feb 12, 2013)

I would think that investing 100% of her portfolio into one investment would not be a good idea due to the lack of diversification which I touched on previously. Also, while 2.5% is not a bad rate its not anything special and the interest income is taxed at her highest marginal rate. While I am not providing a recommendation on investments you can get higher rates for 5 yr term deposits at some FI`s such as Manitoba credit unions and I think others. Could probably get close to the 2.50% with a laddered GIC strategy and perhaps incorporate a TFSA even though the amount would be small. I am sure other posters could provide some other alternatives.


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## OhGreatGuru (May 24, 2009)

As others have suggested, this could get ugly. I sense that OP is asking for advice on the Rate-of-return to try to keep the family discussion centred on "Is it a good financial return" rather than "Was this a wise or fair thing to do"? 

Given that the mortgage pays MIL fixed monthly payments consisting of a blend of interest and return on capital, it may make more sense to compare it to what she could get for an annuity for that amount of money. But you can't determine that without knowing the age and health of the MIL.

If the "return" is not unreasonable, then one can get into questions such as; how financially secure is the mortgagee; is the mortgage registered against the title; how is it dealt with in the will, etc. It is possible this is a reasonable way for MIL to convert her capital to a steady income stream for 25 years. But there are risks and unknowns here.

_FYI my MIL is unable to look after her money because of mental illness._

This is disturbing. It raises ugly questions about whether the person who arranged the mortgage is acting at sufficient arms length to avoid a conflict of interest.

OTOH it could be as simple as the sister-in-law saying to herself "I'm not competent to invest the money; why should Mom pay a financial advisor 2% to invest it in high-MER funds; instead she can hold the mortgage on my home and I will provide her with a steady income for the next 25 years." Ideally you would think that kind of decision would be made in consultation with the other family members, but we don't know what the family dynamics are here.


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## dosvog2002 (Feb 22, 2015)

OhGreatGuru said:


> As others have suggested, this could get ugly. I sense that OP is asking for advice on the Rate-of-return to try to keep the family discussion centred on "Is it a good financial return" rather than "Was this a wise or fair thing to do"?


Yes, that is certainly my intention.



OhGreatGuru said:


> Given that the mortgage pays MIL fixed monthly payments consisting of a blend of interest and return on capital, it may make more sense to compare it to what she could get for an annuity for that amount of money. But you can't determine that without knowing the age and health of the MIL.


She's able to support herself for the next 5 years. Then she'll need an income stream from the investment.



_FYI my MIL is unable to look after her money because of mental illness._



OhGreatGuru said:


> This is disturbing. It raises ugly questions about whether the person who arranged the mortgage is acting at sufficient arms length to avoid a conflict of interest.


Well, this was all arranged about 4 months ago without our knowledge and MIL's mental health dictates that she might not inform us of such matters. We also find out that MIL will be living in the basement of the new house and paying, what we consider too much rent and splitting the utilities 50/50 with SIL. I didn't want to get into these details, but a driving force for us to try and understand this situation is to establish whether this is a sound investment for MIL. 



OhGreatGuru said:


> but we don't know what the family dynamics are here.


We thought we did, but not sure now!


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## dosvog2002 (Feb 22, 2015)

frase said:


> I would think that investing 100% of her portfolio into one investment would not be a good idea due to the lack of diversification which I touched on previously. Also, while 2.5% is not a bad rate its not anything special and the interest income is taxed at her highest marginal rate. While I am not providing a recommendation on investments you can get higher rates for 5 yr term deposits at some FI`s such as Manitoba credit unions and I think others. Could probably get close to the 2.50% with a laddered GIC strategy and perhaps incorporate a TFSA even though the amount would be small. I am sure other posters could provide some other alternatives.


I agree. We have a diverse portfolio spread across property, dividend stocks, and option selling - so we're concerned about the loading of her assets into this investment.


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## dosvog2002 (Feb 22, 2015)

Just a Guy said:


> Are you, or does she have, a power of attorney?


We've found out that SIL has power of attorney. We wouldn't fight her for this, rather let the numbers speak for themselves.


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## birdman (Feb 12, 2013)

Wow, this seems to be getting nastier as the story unfolds. Again, I hope the mortgage is registered which you can check by doing a simple title search. This would also give you the term of the mortgage then you will know what the facts are. Hopefully your MIL signed the mortgage and received independent legal advice but something just doesn't seem right on this whole deal. You mention that you would not fight her for this but one thing that bothers me is family members taking advantage of their aging parents. Not sure if this is the case here and perhaps it is all good and above board. Powers of Attorney are generally designed to help incapable people pay bills, assist with investments, etc. and not for the personal use of the attorney. This transaction seems somewhat grey but how to handle it and what to do seems to be the issue. Hopefully you can ascertain in the mortgage payments are made regularly. Good luck.


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## Mookie (Feb 29, 2012)

This sounds somewhat similar to circumstances with my mother in law and sister in law, except in my case, MIL sold her condo and moved in with SIL. Since MIL is not capable of managing her own money, SIL manages her money, with no transparency with the other siblings. This has caused her to be estranged from the family. Who knows (except SIL) what ever happened with the proceeds of the condo sale or what kind of arrangement they have between them for living expenses. 

Hope your situation has a fair solution. Ours didn't.


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## Just a Guy (Mar 27, 2012)

Yes, a power of attorney is a very dangerous tool in the wrong hands. I've known people who have legally stolen the funds of the person, usually a family member, who entrusted them with the power. Even if you were willing to challenge your SIL, chances are it would be very difficult to overturn. 

Legally speaking, you'd have to prove that they are not acting in the interests of the person...something that is a very grey area...she can also charge for her services...


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## OhGreatGuru (May 24, 2009)

_... MIL's mental health dictates that she might not inform us of such matters. We also find out that MIL will be living in the basement of the new house and paying, what we consider too much rent and splitting the utilities 50/50 with SIL. I didn't want to get into these details, but a driving force for us to try and understand this situation is to establish whether this is a sound investment for MIL. _

To play devil's advocate, you have to weigh this against the value of having Sister-in-law look after MIL in her own home. Would you be willing to have MIL live with you? Or would you be willing to chip in to support her in an assisted living facility? Sister-in-law shouldn't be expected to provide free accommodation and care if MIL can afford to pay. And structuring it this way might be quite reasonable. Tread carefully.


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