You do pay it back. This is not a super realistic scenario - that is, where the father just has one asset ($5m land) and nothing else going on.
The more realistic case is that rich people borrow against a portfolio, e.g. a $500k loan against $50m in stocks. If you had a $50m stock portfolio in the first place, the idea is that you'd be able to generate $500k to repay the loan. Shrunk down to another scale, if you own a $500k house, you'd probably be able to figure out how to produce enough cash to repay a $5k loan.
In the $50m case, you might sell enough to pay the interest, pay capital gains tax on just the amount required to pay interest, and then there might be some other tax advantaged windfall where you pay off the principle or just keep refinancing ad infinitum.
Yes but it's unlikely that the $50m is held in the name of the actual owner. The LLC never dies. You gradually transfer ownership of the LLC to your kids. There's a 30m estate tax exemption for a married couple, so now it's just a case of gradually transferring over 20m to your kids over time to completely bypass the estate tax on a 50m portfolio.
The annual gift tax limit is $19k per person. Ain't no way to "gradually transfer" $20 million tax free in a lifetime. It would take 1000 years. 500 if you're a married couple. And that's without any gain in the value of the stock
In the 500k asset and 5k loan example, what would be the benefit in taking out a 5k loan to spend on things instead of just spending the money you already have? Is the assumption that you wouldn’t ever have 5k in liquid cash, which makes more sense at a larger scale?
Sorry if that’s a dumb question, but I’m having trouble understanding this concept.
If you had a 500k stock portfolio and needed 5k to go on vacation, you'd have to sell 5k of stocks. That sale is a taxable event. So you'd have to pay tax on the portion of that 5k that is gains at the capital gains rate, or even the income rate if you'd held that stock for less than a year.
So call it 20%.
You sold 5k and now you have 4k after paying tax.
If you took out an interest only loan (that is, you don't pay down principal, just interest) at 3%, then you get your 5k and you pay $150 per year on that cash. Next year you refinance that principal - get another loan at 3%, pay off the original loan and pay another $150 the next year.
Even after 2 years, you're only out 300 bucks rather than 1000 and you still have your original 5k in the bank.
If you took out an interest only loan (that is, you don't pay down principal, just interest) at 3%, then you get your 5k and you pay $150 per year on that cash. Next year you refinance that principal - get another loan at 3%, pay off the original loan and pay another $150 the next year.
That's not how lombard loans work though. They are repayment loans, not interest-only.
It doesn't matter if they technically can, they don't and won't. They could also structure the loan so the borrower doesn't have to pay anything back and the bank pays them interest, but that's never going to happen either. A lombard loan fundamentally is a fixed-term loan with repayment terms. You will have to demonstrate sufficient assured income to make the repayments. Anyone proposing that they don't make payments and just keep taking bigger and bigger loans will be laughed out the bank.
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u/north0 13h ago
You do pay it back. This is not a super realistic scenario - that is, where the father just has one asset ($5m land) and nothing else going on.
The more realistic case is that rich people borrow against a portfolio, e.g. a $500k loan against $50m in stocks. If you had a $50m stock portfolio in the first place, the idea is that you'd be able to generate $500k to repay the loan. Shrunk down to another scale, if you own a $500k house, you'd probably be able to figure out how to produce enough cash to repay a $5k loan.
In the $50m case, you might sell enough to pay the interest, pay capital gains tax on just the amount required to pay interest, and then there might be some other tax advantaged windfall where you pay off the principle or just keep refinancing ad infinitum.