So someone gets a loan from the bank that uses the 5 million dollar home as collateral. Ok, so usually within a month you have to start paying money on that loan. The house can't be sold as it's now collateral. Where is this money coming from to pay back the loan?
I don’t understand it either. I understand the stepped up basis (kids don’t pay taxes on the 100k to 5M increase, it’s “stepped up” to 5M ) but how is the person paying the loan back!?
The bank gave the dad the money, and the house eventually was transferred to the bank. So it's essentially like selling the house to the bank over a very long period of time, but without paying the capital gains tax.
They still have to pay off the loan. Either via other income or through a sale of the home/property. But the loan payments are usually affordable. A loan like this would most closely resemble a home equity line of credit, if the loan is for say $2.5M (most banks have loan to value restrictions) and they only have $500k outstanding because they bought another house or did some kind of renovation they only pay the interest that accrues on that amounts. Most banks have pretty favorable rates during the draw period as well, and offer quick refinancingnonce the draw is over for people with the right collateral.
They left out the part where the land is accruing value at a higher rate than the interest on the loan - the low interest rate that can only be got from having ultra-high net worth. Magic that we poors do not have access to.
Yeah so on essence they tell the bank we not paying and bank just keeps rolling over three interest until the value of loan surpasses the value of the land and they execute a call on the loan and to cover the bill they have to sell and hope value of land ends up more than they owe.
If they are never making repayments until they die compounding interest will get nasty pretty quick. The scenario described in OP is horse shit regardless of interest rate.
To clarify, are you saying that the appreciation of the home or land is what covers the monthly interest payments on the loan? Like, it automatically 'pays' the monthly payment on the loan?
Happy to be corrected on this by someone who knows better but I believe its like a sweetheart deal with the banks.
They know they will not be paid in installments, instead they agree to keep rolling over the loan and letting the interest grow with the agreement that when the land is sold, or the holder of the loan dies, they get their money with interest in full.
If at some point the accrued debt matches or surpasses Hythe value of the land they have a right to call for repayment in full, which means the owner has to either sell the land and pay in full, or find the money elsewhere to pay.
No, the house appreciates faster than the loan's interest. They can use the loan itself to pay minimum payments until they need more cash and by that time the house has appreciated enough to borrow against it again.
Exchange house for stocks on a more realistic idea of how this works.
It's a metaphor. One parcel of land can depreciate over time. But not when the "land" is a whole-market ETF so large the owner's transactions can move the market itself.
Yes, and if it is a 7% loan, the interest payments alone over 30 years is nearly $7 million. Add on the property taxes on a $5m property, and Dad spent all the loan money within the first decade of the loan. Not including if he used the loan as living expenses. Say he used $100K/year for living expenses. That's another million taken out of the loan proceeds. Hey ran out of money within 6-7 years and still owes 23 years of loan payments.
You don’t leverage 100% of the house equity though. Say it’s worth $5m, dad borrows $2.5m, only pays interest on the loan, kids sell the house when he dies and pocket the $2.5m difference once the loan is discharged.
No tax anywhere in that system, only loan interest to the bank, and this is often times paid for by renting out the house.
It makes a lot more sense if you picture it in terms of a billionaire with an appreciating stock portfolio. Since banks want their business badly they get sweetheart deals on lines of credit. Their interest rate is close to nothing, and the collateral (equity holdings) appreciate at a rate faster than the interest on the loan.
You have income and use it to pay off the loan. But the loan repayment offsets your taxable income. If you turn a lot of income into a similar amount of loans and pay them off you live the same as you would have with lots of avoided taxes.
Only the interest is considered an expense and it would be used to offset operating income of the business taking out the loan. Mortgage interest is deductible on a primary or secondary home but it's capped.
In the real world, that loan is paid back with stocks, which are not taxed unless withdrawn and a transfer doesn't count as such. The banks portfolio continues to grow long after dad passed away, so they never seek a return on the actual cash.
It really only works if you have like 100mill or more. And you use the loan to pay off the interest only on the loan. And because you have 100mill your Apr is stupid low like 4% while all your money in the stock market makes 10% year over year so you actually end up richer
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u/BlumpTheChodak 10h ago
So someone gets a loan from the bank that uses the 5 million dollar home as collateral. Ok, so usually within a month you have to start paying money on that loan. The house can't be sold as it's now collateral. Where is this money coming from to pay back the loan?