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