Need a mortgage? Try the Bank of Mom and Dad
Spurned by banks, more young homebuyers and homeowners are turning to their parents to fund their home loans.
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When Alison Boesel and her now-husband, Jon Risso, bought their Silver Spring, Md., home in 1999, they got a mortgage from a bank. When the couple refinanced in 2008, they turned to a more familiar institution: the Bank of Mom and Dad. (Bing: How to write a private loan contract?)
The Rissos are part of a trend of homebuyers getting a mortgage from family members — usually parents — when they purchase or refinance a home. Some families lend enough for the entire mortgage. Others provide second mortgages or home-equity loans.
These family loans can help solve two of today's thorniest finance problems: qualifying for a mortgage and searching for a higher return on conservative investments.
The Rissos refinanced when Alison's retired parents, Gail and David Boesel, liquidated their stock-market investments. The Boesels used the proceeds to purchase real-estate rentals and some of their children's mortgages. Their refinance dropped the Rissos' interest rate to 3.5% from 5.875%.
The family used a lawyer to draw up 30-year, fixed-rate mortgages. The kids send their payments without reminders and pay their real-estate taxes and homeowner's insurance.
"Everyone wins," Alison Risso says. "They get a higher interest rate, and we pay a lower one."
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The Rissos also sidestepped thousands of dollars in refinance fees for points, escrow, the appraisal and other lender charges.
The arrangement also provides an unusual sense of security. When, on separate occasions, each of their daughters lost her job, the Boesels offered them the chance to pay only the interest temporarily. "We haven't had to take them up on that yet, but it's nice of them to offer," Alison Risso says.
Not for everyone
Intrafamily lending isn't for everyone. Lenders in these scenarios should carefully consider the effect on their finances, says Howard G. Safer, a certified public account who administers and advises family trusts as CEO of Argent Trust in Nashville, Tenn.
Safer has been a borrower and lender in his own family. He and his brother got home loans from their parents.
"We were still paying up until my mother passed away five years ago," he says. Now, he and his wife are helping their children with home loans.
Safer advises against lending money you'll need for retirement, no matter how much you want to help a child or relative. His rule: "Take care of the senior generation first." A retired person living on $300,000 of savings and Social Security is not in a position to fund a child's mortgage, he says.
Ask yourself if you could absorb the loss if your borrower could not repay. Intrafamily lenders should remember that even responsible borrowers could lose their job or suffer other hardships that could cause them to default, says MSN Money personal-finance expert Liz Weston, author of "The 10 Commandments of Money: Survive and Thrive in the New Economy." If you use a contract, you'd have title to the home. But would you really foreclose?
"Just imagine foreclosing on your son or cousin and then having to face them at future family events," Weston says.
"Your everyday family, this probably isn't the solution for them," says Tim Burke, CEO of Boston-based National Family Mortgage. His company charges a one-time $599 fee to help families draw up contracts and register tax-deductible mortgage liens. Loan servicing, available for an additional $15 a month, includes monthly statements, electronic accounts, escrow, tax-reporting help and customer support. Burke says that about 80% of his clients are parents lending to adult children.
"If anyone expresses an iota of reservation, we really encourage them to not do this," he says.
Instead of lending, Safer says he may suggest an outright gift to help a child with a down payment or closing costs.
Lawyers and do-it-yourselfers
Most family lending takes place informally. A National Association of Realtors poll of homebuyers in late 2011 found that one-third of homeowners had received money from family for a down payment. For 26% of homebuyers, parents made a gift of money. An additional 7% got a loan from a friend or relative.
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Better Homes & Gardens Real Estate, in a 2011 survey, found that one in five baby boomers had given children or grandchildren gifts or loans to help them buy a home.
The arguments for family mortgages are compelling. Even with interest rates at all-time lows, few buyers can qualify for mortgages.
Two-thirds of all mortgages in 2011 were "conventional" loans, backed by Fannie Mae or Freddie Mac. The borrowers had an average FICO score of 762. But 65% of U.S. households have FICO scores of less than 750, meaning that "a good chunk of U.S. households are cut off from mortgage credit on this count alone," according to a recent Morgan Stanley Research report.
Lenders can earn a better return on real estate than on a conservative investment. But the most powerful motive may be the pleasure of helping loved ones get ahead.
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Families should hire a lawyer to write up the agreement or at least review it, says Jeff Schnepper, MSN Money's tax expert and author of "How to Pay Zero Taxes 2012: Your Guide to Every Tax Break the IRS Allows." You should have a promissory note to make the loan legal and to prove to the Internal Revenue Service, if necessary, that the transaction was not a gift, he says. The note also lets an intrafamily lender write off the debt as an investment loss if the borrower doesn't repay.
A deed of trust, or mortgage, is a separate document that ties the property to the loan as collateral. You should register the deed at the county recorder's office, Schnepper says.
Experts recommend contracts to protect all parties in case of family feuds over money, inheritances or who is mom's favorite. Other reasons for a contract:
Gift tax. To avoid paying federal gift tax (see IRS rules here), lenders must charge a minimum rate, called the Applicable Federal Interest Rate. Your contract is your record for tax purposes. For a long-term loan over nine years, the rate is roughly 2.2%. Rates change monthly and by loan term and type. You don't need to file a gift-tax return on gifts of less than $13,000 to any one person in 2012; the limit for married couples is $26,000 per child. There's a lifetime exclusion for $5 million this year per giver. That is expected to drop to $1 million in 2013. No tax is due until all gifts exceed the exclusion limit, Weston says. Be sure to get a tax professional's advice.
Mortgage deduction. For a borrower to deduct mortgage interest from federal income tax, a deed of trust should be filed at the land records office in the county where the borrower lives, Schnepper says. Skip this step and the IRS could charge you for unpaid taxes.
Family peace. A contract spells out your agreement so that everyone can refer to it in case of a misunderstanding. A formal agreement helps lessen the chance that parents will have to become bill collectors. Also, it's an important part of the parents' estate. If someone dies before a family loan is paid off or discharged, the legal record helps the executor settle the estate. It also ensures that the loan is counted as part of the borrower's inheritance.
Safer, who helps families set up real-estate loans for down payments and first and second mortgages, says a promissory note should spell out the penalties in case the borrower misses payments, even if you don't intend to enforce them.
Intrafamily lenders rarely ask borrowers to provide credit histories and financial details, Burke says. "After all, who has more underwriting experience than the Bank of Mom and Dad?" But Weston says this kind of reality check is a good idea. "Getting the borrowers' credit reports and FICO scores before the loan is made will help the lenders to see how well they have paid credit accounts in the past," she says.
Lenders should also ask for borrowers' income, Weston says, to know if a mortgage would push their debt-to-income ratio over 40% — "a huge red flag that their debt load would be too high."
Menu of options
Family lenders use many mortgage types. Some families lend 100% of a child's home purchase. Others refinance an existing mortgage balance or fund home-equity loans or home-improvement loans.
Burke says his customers usually choose amortizing mortgages, in terms from three to 30 years. Amortizing allows principal and interest payments to be stretched over the life of the loan, for smaller monthly payments.
If lenders need their money back sooner, they can amortize a loan over any time frame and include a "balloon" provision, making the balance due in three, five or 10 years. That's essentially asking the borrowers to refinance the loan after they've established a track record of payments that qualifies them for a bank mortgage.
Burke says that since 2010, National Family Mortgage has facilitated around 1,000 real-estate loans worth $44 million. The company notes that it helped earn $26 million in interest for families. It doesn't disclose its average loan size but says the smallest loan was $18,500 and the largest was $1.35 million.
The interest-only option
Another family option is an interest-only mortgage. Advisers may discourage borrowers from these loans because their payments never earn them an ownership stake in the home. But interest-only mortgages can make sense when wealthy parents want to transfer money to the younger generation without paying taxes on it. The low monthly payments on interest-only loans let borrowers use more of their cash to invest in mutual funds, stocks and bonds.
"You need the discipline to do that," however, Safer says.
In wealthy families, it may not matter that borrowers aren't building equity in their home. When the parents die, the loan principal can be forgiven as part of the child's inheritance. The outstanding loan balance is subtracted from the child's share of the estate.
The success of any family mortgage depends on family relationships, Gail Boesel says.
"We have a very good relationship with our children. We trust them implicitly," she says. "People say, 'What would happen if they couldn't pay you?' Well, obviously, we wouldn't foreclose. We would just say, 'This is coming out of the pot for you.'"
Meanwhile, her children's payments enrich the estate they may one day inherit. "Rather than paying your interest to a bank, mortgage company or other robber baron, it's going into our money," Boesel says.
It is of the same mentality of not having children till you can afford them. What if your grandparents would of had the same point of view in both instances?
Another good one is the you are 17 and 364/365 days and you are just a child. Then the next day, You are now 18 and considered an adult! You need to move out and get a job to pay for it all.
Two things come to mind on this last one. Are you saying that you only provided for your children because it was the law? Another question that I always like to ask these same parents is what would they do if they had to work for minimum wage and pay for today's living expenses(where utilities cost more than rent and you buy the cheapest food that causes long term health decline)?
Most would not be able to accomplish it, yet they expect their children who they supposedly love to do it. I'm not saying to pay off your families debts. Because if they get the max they qualify for, they should be prepared to eat cereal for dinner. But if the parents would have properly raised their child, they would know that they need to set priorities where an affordable dwelling is concerned.
Very few are self made people, yet you have these financial "experts" insist that you shouldn't help your children because you need it for retirement. Before there was nursing homes and assisted living communities, there was the homestead. You didn't need it because the family was there to help.
That was what having family values was all about.
I've learned this the hard way, don't ever lend money to family, that's what banks are for. My older brother dropped out of college so I helped him pay off some of his student loans so that he wouldn't get any additional penalties. The next best part was that since I paid off a bunch of it in a lump sum, they took 50% off the student loan balance so even better. The problem is that it's been 2 years since I took on my brothers debt and he's hasn't been good about keeping up with the payments we agreed on. So now I'm not happy to see him when he's around and I feel like we're always talking about money and any excuses he has. He's my brother so I'm not going to force him to pay me, but it's ruining our family relationship.
Don't every lend family money, and if you're retired you need that money to live on. I've worked hard for every dime I've made so far and I intend to use it all the way up until my passing. I'll be there for my kids but I won't be their wallet after they move out.