Use family member's HELOC for rate arbitrage?

Question

Hey BP community - looking for some feedback on this idea...

I'm in the process of buying an investment property outside the US (Cayman Islands), for which I can get a (US Prime + %0.50) variable loan from the local bank.

I did some research and I have a family member with a fully paid home in Ohio with a current value of ~$380k and excellent credit. It seems that family member qualifies for a HELOC up to $200,000 from Third Federal using a rate of (US Prime - 1%), or in other words, a 1.50% better rate than I get here. Given that this individual is not particularly interested in using the home equity for his/her own devices, is quite happy to lend to me at 0.25% above the HELOC rate (yes, I acknowledge I'm very lucky), it seems like it makes sense to take advantage of this rate difference.

I.e. I would borrow from my family member as an investor, who will tap his/her HELOC for the credit. I will then pay back at the +0.25% rate, the $65 annual fee (waived the first year) and (haven't worked through the details on this part yet) commit to a full repayment should the HELOC rate go crazy.

It seems like this is a reasonable way give my family member a return (meager, but otherwise unused anyway), take advantage of the different lending rates, and still meet the obligation to my local bank. Am I missing something here? Besides the general risk of variable rate loans, anything else come to mind?

Thanks!

What am I missing

Brandon Sturgill · Answer

@Dan Dennhardt How is the investment secured?...I'm not familiar with a transaction like this...would this be similar to a warranty deed?...so, you would be buying cash and the relative holds the note?

OR a bank loan?...with your relative in 2nd position....

What's the worst case scenario?...I mean, could the property be destroyed by a hurricane or flood? What is the insurance like on the property?

Dan Dennhardt · Answer

@Brandon Sturgill - good questions! Upon re-reading my post, I realize I've not clearly conveyed the intent here, which is to minimize the amount I borrow from the local bank. > How is the investment secured?...I'm not familiar with a transaction like this...would this be similar to a warranty deed?...so, you would be buying cash and the relative holds the note?

Well it's a bit late for me so pardon if I've misconstrued things, but based on my cursory review of a warranty deed, I don't think it's quite the same. In this case, I am the purchaser. I can obtain a traditional bank-financed loan (20% down, 30 year term, but variable rate) from a local bank here in Cayman. They are willing to lend to me based on investments (I have a fair amount of liquidity in stock/cash) and cashflow (have a stable W2 income).

However, the loan terms they offer aren't great compared to what my family member can get on a HELOC (2.25% APR, variable and fixed to prime) or a fixed-rate home equity loan (3.59% fixed for 10 year term).

As such, the idea is to tap into the home equity from a family member, which provides better loan terms, in order to reduce the amount borrowed. The note would either be unsecured (a lot of trust) or secured in the second position (also a lot of trust). I think we could also secure it with some low risk asset we hold like treasury notes that we'd keep on hand anyway.>What's the worst case scenario?...I mean, could the property be destroyed by a hurricane or flood? What is the insurance like on the property?It's a townhome and everything structural, including foundation/roof/walls and all common plumbing and electric are covered by the Strata (like an HOA) insurance. In a catastrophic event- most likely a hurricane or flood from storm surge given that it's in the Caribbean, the Strata maintains enough insurance to rebuild pretty much entirely, this is part of the Strata fee, which is quite reasonable given the rental rate. For the interior, we would carry sufficient insurance to cover a fire or anything of that nature. I suppose the worst case is that the place is gutted in a hurricane and it takes months to rebuild and get it move-in ready. During the last major hurricane (a 100 year storm in 2004) it took about a year for a lot of places to rebuild. That was based on old and largely unregulated construction, this was built to much more stringent code. I'll have to check if the insurance covers any lost revenue or costs due to displacement... but I doubt it.