Borrowing and Loaning Money With Family Members: How to Make Intrafamily Loans Work for a Mortgage

Making an intrafamily mortgage successful for everyone involved takes due diligence. Here, real estate experts share how to lend to or from your own parent or child in order to buy a home.

An image of an adult mother and daughter looking at numbers on a spreadsheet.
Photo: Getty Images.

Taking a mortgage loan from a bank—or any financial institution—doesn't come cheap. The idea of dealing with compound interest and rates can be intimidating. This makes borrowing money from family and friends that much more appealing—and affordable.

When it comes to the big-ticket purchase of a home, close relatives may be enthusiastic to support and able to help with a cash loan much faster than a bank would ever approve. But while there are many ways that a personal loan between relatives could be a win-win, there are also times when it ends poorly. A well-meaning parent can feel taken advantage of, or a grandchild might wrongly assume a loan was really a gift.

To avoid any hiccups, there are four rules that each side—borrower and lender—must keep in mind. Ahead, real estate pros share their firsthand experience with intrafamily loans and how they made them work with their relatives.

4 Tips for Successfully Accepting a Mortgage Loan from a Relative

01 of 08

Write down your intention.

The fact that you are asking for a loan from a family member shouldn't make you overlook any formal loan processes. Explain what you plan to do with the money: Are you buying a personal home, investing in an income-generating rental property, or starting your own fix-or-flip? The person who is lending must trust your repayment plan—and part of that comes from their being able to assess the property, its value, and your ability to generate enough money to own the property and repay the loan at the same time.

02 of 08

State the amount of the loan and its duration in your payment plan.

State the exact amount you are hoping to get from your relative, as well as when they should expect their money back. How do you plan to make payments? Lump sum or by installments? If you will pay monthly, in which month will repayment start? Nail down these details; both parties must agree—in writing.

03 of 08

Define the interest rate.

Although most relatives would not want to receive interest, some do. Current mortgage interest rates are hovering around 3%. A family friend might only ask for 1%, just so you both make something off the deal. Beyond the interest rate, define if it is compounded daily, weekly, monthly, or not at all.

04 of 08

Be clear about what happens if you don't repay.

You know the consequences for defaulting on a mortgage loan from a bank. You better believe there should be consequences if you fail to repay your own parent, child, or other family member.

Create predictability by setting a fee for late payments—and define what can be repossessed if the loan isn't fully paid on time. In some cases, the lender might want to take over the deed to the house. In others, the lender might prefer to extend the deadline at a higher interest rate or a large sum. The possibilities are endless, which is why you and the family member lending to you must negotiate these terms.

A real life win-win situation: There are countless benefits to taking a private loan.

Olivia de Oliveira is a real estate investor in Memphis, Tennessee, and the owner of Restoration Properties, LLC. To buy her personal residence, she took out a 30-year private loan (with compound interest) from her mother. They used a real estate attorney to prepare a Promissory Note and Deed of Trust.

"My mom had money to invest, so I asked her to give me a private loan to purchase my home," Oliveira tells Parents. "I am paying her a good interest rate, and the promissory note lays out terms just like any other mortgage," she explains. There's a 4 percent late fee if payment isn't received by the 15th of each month, and her mom can foreclose on the house if de Oliveira defaults on the loan.

Although the rate isn't cheaper than the bank rate would be, this arrangement is very beneficial to de Oliveira because, as an investor, this loan doesn't show up on her credit report; plus, she saved on origination fees and didn't have to put any money down. This frees up her capital for other investments—and she can still write off the mortgage interest on her taxes.

Oliveira says things have worked out so well with her mom that if her mother were interested in lending her money again for another real estate project, she'd agree.

4 Tips for Successfully Financing a Mortgage Loan to a Relative

If you are lending money to a family member, you should know that there are risks involved. Of course, you want to protect your money, but you also want to protect your reputation and the harmonious relationship you have with other family members.

For example, your daughter might be jealous to learn that you lent a chunk of change to your son, when she had a competing need for the money too. So, examining the relationship sensitivities is just as important as being aware of the available funds.

There are four simple things to keep in mind if you're entertaining granting a loan to a family member for the purchase of a home.

05 of 08

Only lend what you're prepared to lose.

Sure, you should take the tough route and be sure that the borrower knows that you do expect your money back—and on time. But, if things turn sour in your family as a result of their inability to pay, you have to be clear about whether or not you'll go so far as court and legal disputes to get your cash back or if you're willing to let bygones be bygones. Don't dump your life savings into a beloved child, parent, or relative's home purchase if you really can't afford to see that money disappear into thin air.

06 of 08

Ask about other competing loans.

When banks agree to offer a mortgage loan, they ask to see how many other loans the borrower has outstanding, how much income they're receiving, and their credit report. It's not just to be nosy; it's to see if this person will really be able to carry this loan all the way to full repayment.

Although your relative might be offended if you ask for all this information, know that it is your right to know. If they are taking out a loan from you for the down payment on a home and still have to pay a monthly payment to a mortgage company, be realistic about whether they are truly making enough to pay you both. The same is true if they have lots of credit card debt or a history of fiscal irresponsibility. If the loan is sizable, do some kind of underwriting before taking their word for it.

07 of 08

Plan for the worst-case scenario.

Heaven forbid that you fall sick, are incapacitated, or worse. What do you want to happen to the loan? Is it due in full? Would it pass to your heirs or estate? Do you intend for it to be forgiven? Think about the worst-case scenario—and put it in writing. Share this with the relatives who would be affected, so that they can execute your wishes, if you're not able to do so yourself.

08 of 08

Prepare emotionally to watch and wait.

Chances are, if you're lending a relative money for a home, you truly love them. You want the best for them. But, giving them a loan doesn't give you the right to be intrusive, especially if they're paying you back under the agreed upon-terms.

Remember: Your loan does not mean you're entitled access to their home (the mortgage lender doesn't have the keys to your front door). Also, it may be hard to watch your loved one make decisions you disagree with—especially if they could affect your loan terms. But, as long as they're making the necessary payments to you, you have to be emotionally prepared to butt out.

A real-life win-win situation: Get creative with the loan structure.

Robert Taylor used his fix-and-flip company, the Real Estate Solutions Guy, to work out a deal with his 20-something son.

"We found a home for sale that was not financeable because of its condition," Taylor tells Parents. "I asked him if he was interested in the home, if we could make the finances work for him. My company would buy the home for cash and then rehab it. Then, we would flip the home to my son. The difference was that we would sell it to him at a price he could afford," Taylor explains.

They got an appraisal for the new value of the rehabbed home, and his son got a bank loan for the amount he could afford. This allowed them to set up an equity participation agreement to make up the difference between the affordable price that the son paid ($180,000) and the full appraisal value of the home ($250,000). When asked how this works, Taylor says his son "would own 72% (180,000/250,000) of the value of the home. Our company would own the remaining 28% of the value. Any appreciation would be shared between us."

Other than that, though, "the purchase would look like any other home purchase," Taylor reiterates. "While we owned a portion of the equity, we did not own the home; ownership was completely my son's. He could keep the house for as long as he liked or sell it whenever he wanted to."

They recorded the sale to Taylor's son, and there was a deed of trust. When his son decided to sell the home a few years later, the proceeds were divided according to the equity participation agreement—and they both earned a good profit.

The bottom line.

Not only is it possible to conduct a successful intrafamily mortgage loan, but there can also be untold benefits for both sides. That said, it is important to remember that this is a business transaction. Even if this is your own child or parent and you've known this person your whole life, both parties must do their due diligence to make smart money decisions with their heads—not leaps of faith with their hearts.

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