Banks and other financial institutions play a wonderful, indispensable role in our economy. They are the intermediaries that most efficiently bring together large numbers of savers looking for a safe place to store their money and borrowers, looking for money to spend they do not presently have.
Our economy couldn’t do without banks.
But that doesn’t mean you’ve got to use them every time for every transaction. There are a few occasions where getting rid of the middle man makes sense.
I’m thinking of a situation. Let’s call them Joe and Jane Jones. The Jones have two car loans ($55,000 total) and five maxed out credit cards ($45,000 total). They’ve got $100,000 in non-mortgage debt, paying interest rates ranging from 5% to 21%. They pay about $2,250 each month to the debt monster. It’s painful.
Meanwhile, Joe’s parents don’t come to visit as much as they used to. It’s not that they don’t love Joe and Jane. They’ve simply had to cut out all non-essential expenses, including travel.
Joe’s dad can remember when the CDs he had at the bank paid anywhere from 5% to 7%. That interest income paid for a lot of the “fun extras” in their lives. For now, they’ve had to tighten the belt and travel has been one of the casualties of the low interest rate reality.
No one quite remembers when the light bulb went off, or whose bright idea it was. But one day someone realized that Joe and Jane were paying too much to banks and Joe’s parents weren’t getting enough from banks.
Maybe there was some way to get together.
With the help of their CPA, Joe and Jane arranged for an “intra-family loan” from Joe’s parents. Joe borrowed $100,000 from his dad and paid off both of his car loans and all of his credit cards.
His dad treated the loan just like he would a CD. It was a source of retirement income to him. But instead of getting the meager rates banks are paying today, Joe was able to pay his dad 5% annual interest. Since Joe’s dad wanted to keep earning 5% on the entire amount, Joe only paid the interest on the loan (for now).
Joe went from paying $2,250 a month to less than $500 a month. Joe’s dad went from getting about $500 a year on his CD to getting nearly that much every month ($417) from Joe.
Now, Joe can save and invest the $2000 per month that he was sending to the bank. If he just earns 3% on that money, he’ll have $100,000 (with which to pay back Dad) in less than four years. But depending on what interest rates are doing, Dad may not want his money back. Joe may be his best bet on earning higher than average yields on his (former) CD money.
It should be obvious that intra-family loans rest on a bedrock of trust. If the borrower is irresponsible, this should never be done. The process should be formalized and a legally binding note signed. It’s a loan, not a gift. So this strategy is not for everyone.
But in the right circumstances, excusing the middle man from the process may benefit everyone.
Everyone in the family, that is.
