Joe was a hard charger who'd had a heart attack and wanted to retire. I'd been leasing his 3 free and clear houses with a ten-year Option to buy for 4 years. I had 6 more years left on the original 10 year term and really didn't want to terminate what had turned out to be a pretty good deal; so we negotiated.
My Option strike-price was $160,000. In return for my giving up the 6 year unexpired portion of my lease and paying him $20,000 in cash, Joe agreed to carry the financing on all three houses for 10 years at zero interest. Additionally, I agreed to pay Joe $2000 each quarter in advance every three months for the next 40 quarters, over ten years, after which $60,000 would be due and payable.
We closed the transaction, and I commenced to make my payments to Joe out of the rents received. Paying quarterly helped me even out the cash flow when I had vacancies and expenses.
A few years later, Joe's daughter got married in Hawaii and he asked me for an advance on my payments so he could attend the wedding. I countered by offering to lend him $5000 at 18% interest, but with no payments. I pointed out that, if I paid him in advance, this would be taxable, but if he borrowed the money, it would be tax free. The interest would simply accrue and compound until my final payment to Joe fell due. At that time Joe's loan balance would be subtracted from what I owed him.
Joe liked the idea of delaying his taxable event and borrowing without having to make payments; just allowing his interest to accrue. The 18% didn't bother him at all. After all, he'd been paying this much interest on his credit cards for years. He liked the deal so well that he continued to borrow in dibs and dabs over the years. When the final payment day came, Joe owed me $47,823 which was credited against the $60,000 I owed him. I paid him off with $12,177.
If you take a close look at this arrangement, I was just lending Joe his own money that I'd borrowed at zero interest and charging him 18%. Normally, I'd feel pretty guilty about this, but my bank has been doing this to me all my life; borrowing my checking account balance for zero interest and lending it back to me for credit card, business and mortgage loans. The Federal Reserve has been doing it to the U.S. Treasury as well. You can do it too with this technique.
