Using A “Family Mortgage” To Purchase A Home
Current mortgage rates are low and closing costs have dropped. However, if you’re looking for the “best deal” on a home loan, the best place to look may be within your family.
For decades, home buyers have used intra-family loans to purchase homes, often saving money on interest rates and costs; and, getting access to an alternate source of low- and no-down payment home loans.
Not all buyers will have the fortune of asking family members to finance a home purchase but, for those who do, the benefits can be huge.
As compared to borrowing from a bank, loan terms can be more favorable when you borrow from family. However, you can’t count on the same legal safeguards, and there are some serious pitfalls to avoid.
When you give a family mortgage, then, you’ll want to protect yourself from potential legal problems and, potentially worse, long-lasting family squabbles.
There’s a right and wrong way to do the “Family Mortgage”.
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Family Loans: Get It “In Writing”
A mortgage, by definition, is interest in real estate in exchange for a loan. The mortgage is given by the homeowner, and held by the lender.
When you mortgage your home with a family member, in other words, you’re giving a family member rights to your home in exchange for the money you need to buy it.
When the loan is paid-in-full, the family member’s rights to the home are “released”.
Clearly, for a transaction this important, a document is required — in writing — which states “this is a loan”. Such a document protects everyone involved.
It also opens everyone to the tax advantages homeownership can provide.
At minimum, you’ll want a signed promissory (or mortgage) note; and a properly executed Deed of Trust.
The mortgage note is your signed promise to repay the loan. The note will include the amount borrowed from your family member, the interest rate at which you’ll repay the loan, and the due dates of your payments.
The mortgage note will also describe what happens if you are late in making payments, or default on your loan altogether.
The Deed of Trust is a different type of document. It’s a document which states that your home is mortgaged, and that your family member is legally able to foreclose on you and sell your home in the event that you fail to pay your mortgage, your property taxes, or your hazard insurance, as agreed.
The Deed of Trust is filed with your County Clerk or Recorder and is public record.
Without these two documents, your “loan” may be unenforceable.
An Attorney Should Draft Your Loan Terms
The internet is a wonderful resource when you’re in search of answers. And, there is no shortage of websites offering template documents to help you with your intra-family home loan.
However, given the value of the home that you’re buying, and that the home will likely be the largest asset you have to your name, using the qualified counsel of an attorney is advised.
You’ll pay more for your lawyer than a mortgage note you find online, but you’ll know you’re doing things right. It’s not just you who needs legal protection, after all — your lending family member does, too.
Even a small mistake could subject you or your relative to unexpected income taxes or gift taxes, both of which can be high.
An attorney can also help you establish solvency as a borrower, which proves that the loan from your family member is not just a “gift” in disguise; and to craft the mortgage language so that the loan is “demand loan”.
Make Your Family Mortgage Like A “Bank Mortgage”
Making your family mortgage a demand loan means that your relative can, in theory, request full repayment at any time.
This is important from a tax liability perspective.
Loans not categorized as demand loans are subject to IRS interpretation about whether they are, in fact, a gift, where the “gift” is the amount of mortgage interest not paid over the life of the loan.
For example, a $300,000 loan at today’s mortgage rate would accrue $216,000 in interest payments over a 30-year loan term. A family mortgage not designated as a “demand loan”, therefore, could put a $216,000 gift tax liability to the giftor.
An attorney will cost you several hundred dollars more than buying a Family Mortgage template online. The extra cost of the attorney is cheap, however, as compared to what not using an attorney could cost y.
An attorney will also make sure you don’t get “undercharged” on your Family Mortgage interest rate. That, too, is an IRS trigger which could subject you to an unwanted tax liability.
Editor’s Note: Consult a tax professional before making tax-related personal finance decisions. This site does not offer tax advice from licensed tax professionals.
What Are Today’s Mortgage Rates?
Borrowing from your family can be an excellent way to save on your mortgage and save on your costs. However, you’ll want to make sure you stay above board and protect yourself legally.
If all this seems too much, there’s always the traditional home loan route via the banks. Mortgage rates remain low and lenders are approving loans at a higher frequency than during any period this decade.
Get today’s live mortgage rates now. Your social security number is not required to get started, and all quotes come with access to your live mortgage credit scores.
Verify your new rate (Aug 31st, 2020)