Tuesday, April 23, 2024

Scott,
Our daughter, who is 31 and single, has $15,000 in credit card debt that would we like to help her get out from under. This debt consists of two different maxed out credit card accounts that are both charging very high interest rates, as well as late charges and over the limit fees. We are considering refinancing our mortgage, which currently has a balance of $47,000 and a 5.75% rate. We will continue to make the same payments we're making now, and she will make the additional amount needed to pay off the loan in about 6 years. That way she would not have any debt showing up under her name, and we would be able to take the additional interest off as a tax deduction. Even though there would be closing costs involved on a refinance, I still feel that those charges would be less than the interest on the credit cards over the long term. Is this a good solution or not? By the way, we have had several lengthy discussions with her about how to manage her finances and also purchased your "How to be more credit card and debt smart" manual for her. 
--Anna

Anna,

Thanks for writing and getting my book!

Great question especially considering that last issue's survey was about lending to family. The good news is that it seems, from those results, that lending to family works out better than lending to friends. Also, I'd like to speculate that lending to your children, in general, could work out well. The last thing anyone would want is a damaged relationship over money.

I believe that your plan is a good idea. And I believe this for many reasons. First of all, you are going to be saving money by refinancing and you're going to be saving money for your daughter by reducing her interest rates. Second, because the rate reduction is in the form of a mortgage you get that tax benefit. Third, once her loans are paid off by the refinance, they'll be off of your daughter's credit report.

Now let's crunch some numbers. If she's going to be paying this loan back in exactly six years, then a principal of $15,000 at 5.75% requires a monthly payment of $246.83. However, if you really wanted to work out the numbers there are still other cost considerations--closing costs for example.

If you were going to refinance anyway, then you would have paid all the costs that involve the property like legal, title work, loan applications, etc. regardless of lending to your daughter. However, if there are points involved then your daughter's portions would contribute to increasing that cost. If there is a charge of 2% on a $15,000 mortgage, then your daughter's portion of that charge is $300 ($15,000 *.02 =$300).

On the other side of charges, you will be receiving a tax refund based on the loan and extra savings because of her additional loan. You could refund that amount to her by simply reducing the rate of the loan based on your tax bracket.

For instance, if you are in the 15% tax bracket, then subtract .15 (15%) from 1.00 (100%), which is .85, then multiply that number by your current APR to find your new APR (5.75 * .85 = 4.89). This gives you the new interest rate of 4.89%. This reducing in interest represents the amount you'd be receiving as a refund based on your daughter's loan.

The 6-year, monthly payment of $15,000 at 4.89% is $240.81.

Now that your daughter will have no outstanding credit card balances, she'll need to be careful when spending. I suggest only using her credit for emergencies and budgeted spending. Managing credit overlaps managing spending.

Hope that helps!

Please let me know how it all works out!

Regards, 
Scott

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