Can a friend put up collateral for my secured loan?


Short answer: yes, you can put up collateral for someone else's loan. The bank will be happy to take your money, give it to the other person, and return it to you on completion of the loan (keeping the interest the security makes on the money market and the interest they're charging the other person for themselves).

If the above doesn't sound very appealing (you don't see any benefit from your investment, and can be left holding the bag if your friend defaults on their loan), it really isn't a great way to spend your money. However, as assistance to someone else, it provides several advantages over directly transferring the money:

  • The lendee gets a better rate than they normally would from the bank - Basically, from the bank's perspective, the loan's covered, so there's very little risk of a default leaving them holding the bag. As such, they can typically offer rock-bottom, cost-of-capital rates.
  • The lendee builds credit history - Since the lendee is making payments on a legitimate, structured loan to an entity that reports to the credit agencies, this is a very good way to help the lendee build good credit.
  • You avoid the gift tax - If you lend over $13k, unless there's a contract between the two of you stipulating a schedule of payments, it's a "gift" as far as the IRS is concerned and you will be taxed on the amount above the exemption. EDIT: The $13k figure (going up to $14k for 2013) is only the limit if the loan is not a loan, but in fact treated as a gift (i.e. no reasonable prospect of repayment). For bona fide loans, there is no fixed upper limit on the amount you can loan, but the gift tax will be determined based on the difference between the interest charged and the "applicable federal rate" (this rule is found in IRC Sec. 7872; check IRS.gov for monthly Rev. Proc.'s listing newest AFR's). Last time I checked the short-term and medium-term rates were around 0.2%, so if this still holds it's an excellent time right now to "gift" your credit at little to no gift tax cost. One can even take advantage of this by making so-called "back-to-back" loans- taking out a HELOC at 4% and subsequently loaning proceeds to your child at .2% (or whatever the current AFR), producing no taxable gift on the 3.8% difference.
  • The lendee may be able to deduct interest - depending on the type of loan (maybe the $20k is the 15% of an 80-15-5 mortgage), the interest paid on that loan can be tax-deductible. A personal loan between friends? No way.

There is no need for micropayments, monthly payments, or harassment.

A loan agreement can be drafted that your mom makes one payment annually to youinstead of monthly payments. Depending on what she (and you) might be comfortable with, this payment could be interest only, or partly interest and part repayment of principal. Or you can set it up so that there is a balloon payment due when the loan terminates (say in five years' time) and she pays back the entire principal and accumulated interest. If you trust her to pay back the money, you don't need to ask for collateral or security, and you don't need toturn the debt over to a collection agency or send large men withbaseball bats to call on Mom.

If you just want mom to return the principal when she is ready to so so,and don't really want to charge her interest, then set up the loan torequire annual payment of interest only (and the entire principal at the end of the agreement). Then, each year, a few days before the interest payment is due, send her a check for the interestdue as a gift. Mom deposits the check in her account and sendsback the interest payment to you. So, no harm, no foul: you have made her a gift (presumably less than the $13K exemption), she haspaid you interest, but there is no net transfer of money, andas far as the IRS zebras are concerned, this is a legitimate loan.Do keep copies of the paperwork, though, and be sure to reportthe interest payment on your income tax returns as income to you.By extension, if you don't really want the money back, set upthe loan so that the annual payment is $13K and is part theannual interest due and part the principal until the loan is paid off.


Since this is the reasoning:

I don't want to bother with micropayments, and harassing her for monthly payments.

You must do one the following:

  1. Provide the money to your mom as a loan (i.e.: with a note and interest) payable when the full repayment of the loan to the bank is done (i.e.: balloon note). The terms of the note should be that the money to be used as collateral for the secured loan from the bank.

  2. Provide the money to your mom directly. In this case you have to pay gift tax on $7K (above the 13K exemption limit).

Since you want the money back - you'll probably want the option #1. Your interest rate should be above a certain level to avoid reclassifying it as a gift by the IRS (your tax adviser can help you with that). Your mom will pay interest to the bank on the secured loan, and to you on the collateral (unless you wave it, subject to gift tax, again - talk to the tax adviser). You will only need to harass your mom about the balloon payment in the end.

This is not a tax or legal advice. Talk to your tax adviser and a legal counsel about the details and additional options.