Questions on personal loan - tax implications and interest rate

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<p>I am hoping that someone here can give me some information. My sister is my tax advisor, and she is not available right now. I will probably have to make some decisions before I can speak to her.</p>

<p>As exhaustively detailed in the thread about lending to family members, my DH and I are about to make a loan to his brother, who is in hot water financially and has an immediate need for a lot of cash ($25-35k). We are going to tap our HELOC to get the money, and we will do this through Virgin Money, almost certainly making it a 3rd mortgage on his home. There is plenty of value in the home above the existing mortgages, even in a bad market, and he is expecting an inheritance within the next year. </p>

<p>The principal and interest will be paid in a lump sum when he gets his inheritance or sells his home, whichever comes first, and in any case within a fixed period, probably 3 years. This will be done by making the mortgage a 3 (or so) year term, with a demand clause enabling us to demand payment within XX days. We will make it clear that this clause will be implemented when the inheritance comes or the home is sold.</p>

<p>The costs of arranging the loan ($549 for VM’s fee, between $500 and $1000 for mortgage recording tax) will be added to the principal so we will get it back eventually, but we will have to pay the money up front. Can we deduct this from our income taxes for this year? We don’t have any other personal loans, although we do get some interest from money markets. </p>

<p>I am trying to figure out what interest rate to charge. DH and I had thought that we would just pass along our cost (the HELOC interest rate). I called the bank and at the moment it is 3.75%, tied to prime (plus 0.5%). So it will vary. Also, we will have to pay income taxes on the interest we get at the end. So I was thinking that we should set the interest rate higher to compensate. The person I spoke to at VM said that a given interest rate in a HELOC is effectively different from the same nominal interest rate in a mortgage because they are applied differently. Can anyone enlighten me here? I’m trying to be fair, but I really want to guard against this costing us money.</p>

<p>Also, I noticed that average HELOC rates on bankrate.com (around 5.3% for $30k) are much lower than rates for home equity loans (close to 8% for $30k). Is this only because the HELOC rates are, presumably, variable? Or is there some thing else going on? Does it indicate that people expect interest rates to go up a lot?</p>

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<p>The calculation of interest and amortization of HELOC is different from a conventional scheduled loan. For short time periods and small amounts, the difference is very small. </p>

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<p>Helocs are typically variable. Many Helocs are held by the lending firm and not sold or cannot be sold to other financial institutions because these other FI’s cannot adequately gauge the risks. Whether or not rates will go up is not the entire issue-but rather if there are other investments that can return a profit. </p>

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<p>What is quoted on bankrate is not necessarily what lenders are actually doing. I would guess that the true lending is closer to 8% for excellent credit and home equity in a good housing market locality.</p>

<p>Await other replies. Essentially your questions come to the heart of our National Financial Crisis. IMO. </p>

<p>shop the terms of the loan and not necessarily the rate.</p>

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<p>Thank you for your response, LongPrime. I am lacking in knowledge of this field, though, and I didn’t understand everything you posted. I see your point, which I hadn’t thought of before, that HELOCs are not bundled and chopped up and sold around the world (as I only recently learned regular mortgages have been), but stay with the lending bank. I’m not sure why this would make them cheaper? </p>

<p>Is bankrate.com inaccurate? The numbers I looked at were supposed to be national averages. By “true lending” do you mean that HELOCs are going for 8% for excellent credit, lots of equity, and a good housing market, or that home equity loans are going for 8%?</p>

<p>I’m interested in your comments about the relationship between my questions and the financial crisis - do you mean that the fact that mortgages were turned into securities and derivatives and CDS, etc., instead of remaining mortgages is the source of the crisis?</p>

<p>What do you mean by “shop the terms”?</p>