Many firms offer a version of 100 percent financing that enables parents to do the same thing for their adult children.
Parents can pledge assets that will enable a child to avoid having to come up with a down payment. If the child wants to purchase a $300,000 home, he or she would need to come up with approximately a 20 percent down payment of $60,000.
Alternatively, depending on the institution, the parents can pledge roughly $120,000 of assets. This pledge will enable the child to have a 100 percent loan with no PMI (private mortgage insurance), and the parents' accounts stay fully invested in their investment strategy.
The parents are not cosigners, and they are only at risk in the event that the child stops paying the loan. In essence, they are there as a backstop or additional collateral in the worst-case scenario. The parents' assets continue to be invested, and whatever returns they generate go exclusively to the parents' account. The parents can typically continue to buy and sell investments, just as they normally would, as long as the assets they are buying and selling conform to ABLF requirements and they maintain the minimum amount required by the firm in the pledge account. This is a very
powerful tool for families to discuss and consider (but read Appendix F, first!).
This can enable the purchase of a $300,000 property at, say, 4 percent fixed:
$300,000 × 4% = $12,000 per year/12 = $1,000 per month. This $1,000 would be a tax deduction to the child. Additional savings from this strategy should not go to paying down the mortgage. They should go to building up cash, retirement plans, and liquid investments.
The family should work together to determine whether a fixed or floating mortgage is a better decision. If you choose fixed, remember that you are only trying to insure against rate movement during the time period the child anticipates owning the
property. It can generally make sense for conversations to start around loans that are fixed for five to seven years (interest only) and adjust up or down from there.7,8
Notes
1. Stephen A. Ross, Randolph Westerfield, and Jeffrey Jaffe, Corporate Finance, 10th ed.
(New York: McGraw-Hill, 2013), Chapter 15. This is true with respect to corporate bonds. There are examples of certain asset-backed securities such as equipment trust certificates that railroads have used (among others) that either have direct
amortization or a toggle feature that can trigger amortization. There also are mortgage- backed securities that contain an income stream that is comprised of both principal and interest payments. Many private company bank loans are subject to amortization terms. The fact that these loans and securities exist does not exclude the fact that publicly traded corporate debt is issued on an interest-only basis.
2. While no public traded companies issue bonds with built-in amortization, there are indeed amortizing bonds issued in the private equity markets. Also, corporations will establish sinking funds for their bonds where the money needed to repay the principal is put into escrow. However, the company still controls the cash and the ongoing
payments they make on their debt will be interest only, that is, the only time you will receive a repayment of the principal is when the bond is called or matures. An
individual can, of course, create a sinking fund as well.
3. “Median Effective Property Tax Rates by County, Ranked by Taxes as a Percentage of Household Income, 1-Year Average, 2010,” The Tax Foundation, July 27, 2012. See http://taxfoundation.org/article_ns/median-effective-property-tax-rates-county- ranked-taxes-percentage-household-income-1-year-average.
4. Yingchun Liu, “Home Operating Costs,” HousingEconomics.com, National Association of Home Builders, February 8, 2005. See www.nahb.org/generic.aspx?
sectionID=734genericContentID=35389&channellD=311.
5. Ross, Westerfield, and Jaffe, Corporate Finance, Section 21.9: Companies lease many assets.
6. See http://online.wsj.com/articles/a-florida-home-on-private-peninsula-will-list-for- 60-million-1409948247 (September 5, 2014).
7. Case studies are for educational and illustrative purposes only. They assume eligible assets and that funds are available on the facility. All client situations are unique, and all loans are subject to eligibility and approval by the lender. A lender may deny an advance on an ABLF, preventing the scenarios. Pledging assets reduces and may eliminate liquidity. A market correction could impact market values and/or security eligibility, which could impact the facility size and/or trigger a margin call and/or forced liquidations of assets. See complete disclosures and risks to using an ABLF in Appendix F.
8. Author's Note: The information in this guide is to be considered in a holistic way as a
part of the book and not to be considered on a stand-alone basis. This includes, but is not limited to, the discussion of risks of each of these ideas as well as all of the
disclaimers throughout the book. The material is presented with a goal of encouraging thoughtful conversation and rigorous debate on the risks and potential benefits of the concepts between you and your advisors based on your unique situation, risk
tolerance, and goals.
Part V