Sunday, August 29, 2010

Lender of First Resort

Neither a borrower nor a lender be,
For loan oft loses both itself and friend,
And borrowing dulls the edge of husbandry.
Hamlet Act 1, scene 3

Sound advice given by Polonius to his son Laertes, but there are times when one cannot avoid borrowing money, such as when buying a home. The usual solution is to borrow from a bank, but there are some fortuitous circumstances in which we can do better.

The banking system is a pass-through mechanism, it is a borrower from some and a lender to others. The banks charge a good vig for the service: today you get no more than 1.5% on your deposits but pay at least 5% on a mortgage. That's a 3.5% spread, which of course includes not only profit for the bank but also servicing fees, bad dept provisions, etc. That's $3,500 for every $100,000 borrowed just in the first year, on top of mortgage initiation costs!

When my father bought a new house several years ago, he borrowed money from friends and family rather than going to the bank. He paid a rate that was between what we were getting in a bank at the time and what he would have to pay on a mortgage (today, that'd come out to about 3.25%) which was a big win for everyone - both the lenders and the borrower got better rates than they would otherwise. Additionally, he benefited from having no mortgage fees and the ability to make "all cash" offers on properties.

Of course before you lend significant sums to your friends and family, you must be very extremely comfortable in their willingness and ability to repay you back in the agreed manner. But when it works, it's a beautiful thing.

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