Things to think through for a family home loan
May 5, 2009 11:39 AM Subscribe
Family home loan filter: We are going to be setting up a loan from a family member for our first home purchase, what do I need to know?
We were going to borrow a small amount to help out with the downpayment to get us to 20% down. Long story short now we are going to put down what we have, and take out a loan from a family member. Basically, he has money he wants to invest, so we decided on 4% interest for 5 years, and if the economy has taken a turn for the better, we would bump the 4% to 4.5%.
So, I like this option as we save a TON in closing costs, as we were planning on buying down the interest rate, and we also don't have to pony up all of our savings to avoid PMI.
But, this is our first home purchase, so we want to be sure to do things right insofar as getting our tax credit. We will be making payments directly to the family member. The family member has been a business owner for a long time, and so he has a lawyer and an accountant who will help them figure out all of these things. But I thought asking the Hivemind to share thoughts and personal experiences would also be beneficial as we think through this.
I do not have any concerns as far as borrowing money from a family member, as it will all be well documented and our relationship is solid and open.
But, what are some things I need to make sure happen? Will I still be able to deduct the interest I'm paying? Will they need to provide tax forms for me? Special steps to insure I will be able to get the credit? Will this have any effect on my credit?
Thanks!
We were going to borrow a small amount to help out with the downpayment to get us to 20% down. Long story short now we are going to put down what we have, and take out a loan from a family member. Basically, he has money he wants to invest, so we decided on 4% interest for 5 years, and if the economy has taken a turn for the better, we would bump the 4% to 4.5%.
So, I like this option as we save a TON in closing costs, as we were planning on buying down the interest rate, and we also don't have to pony up all of our savings to avoid PMI.
But, this is our first home purchase, so we want to be sure to do things right insofar as getting our tax credit. We will be making payments directly to the family member. The family member has been a business owner for a long time, and so he has a lawyer and an accountant who will help them figure out all of these things. But I thought asking the Hivemind to share thoughts and personal experiences would also be beneficial as we think through this.
I do not have any concerns as far as borrowing money from a family member, as it will all be well documented and our relationship is solid and open.
But, what are some things I need to make sure happen? Will I still be able to deduct the interest I'm paying? Will they need to provide tax forms for me? Special steps to insure I will be able to get the credit? Will this have any effect on my credit?
Thanks!
You might consider linking your interest rate to the prime rate. This is a well-publicized, easily ascertainable rate on which most lending rates are based. So something like "Locked at prime at the date of disbursal +.75% for two years then floating at prime +.75% after that". It's unambiguous, everyone knows how to figure out the rate, and as prime can't really go down any farther, your interest rate won't either.
As to deducting interest, talk to your lawyer and accountant. You've already got the expertise read to hand, and they'll be able to answer those questions and set things up for you. Your accountant will probably generate the relevant forms as part of his fee.
posted by valkyryn at 12:47 PM on May 5, 2009
As to deducting interest, talk to your lawyer and accountant. You've already got the expertise read to hand, and they'll be able to answer those questions and set things up for you. Your accountant will probably generate the relevant forms as part of his fee.
posted by valkyryn at 12:47 PM on May 5, 2009
FYI, your mortgage lender is going to want to know that you're getting your down payment money from another loan, so you'll have to disclose that, and it may affect the terms of your mortgage.
posted by decathecting at 12:47 PM on May 5, 2009
posted by decathecting at 12:47 PM on May 5, 2009
Best answer: Here's some general advice from a LA Times article:
Contemplating a loan from a family member? Here are some things to consider:
* Not all lenders will go along with second mortgages that have been privately obtained. If you plan to use a family loan in combination with an institutional one to purchase a home, make sure the lender you choose allows the arrangement, advised John M. Smith, owner of Old Mission Mortgage in San Diego.
* Document and record the loan. You can do this yourself by downloading a form for a promissory note secured by real property. Several websites, including www.lawdepot.com and www.uslegalforms.com, offer standard legal documents for a nominal price. Fill out the form, then record a trust deed on the property with the county recorder's office. Or you could hire an escrow or title company to help you.
Recording the loan helps to protect both the lender and the borrower and could help to circumvent family resentments. Also, if the borrower plans to count the interest payments as a tax deduction, it is critical to show the IRS that the transaction is legitimate.
* To ensure that the borrower qualifies for tax deductions, the person giving the loan must charge an interest rate no lower than a rate set by the federal government. If the rate is too low, the IRS will consider the interest income a gift to the borrower. The minimum rate, known as the Applicable Federal Rate, changes monthly and can be found at www.irs.gov. At the site's home page, search for the phrase "Applicable Federal Rate," then click on "Index of Applicable Federal Rates." Last week, the minimum rate that could be charged on a 30-year loan was 4.79%.
* With a private loan, the lending family member or friend can receive the interest income and pay taxes on it. Or the lender can opt to forgive a portion of the interest or the principal in the form of an annual gift. Tax law allows an individual to give a gift of up to $11,000 to another individual per year tax-free.
posted by burnmp3s at 1:01 PM on May 5, 2009
Contemplating a loan from a family member? Here are some things to consider:
* Not all lenders will go along with second mortgages that have been privately obtained. If you plan to use a family loan in combination with an institutional one to purchase a home, make sure the lender you choose allows the arrangement, advised John M. Smith, owner of Old Mission Mortgage in San Diego.
* Document and record the loan. You can do this yourself by downloading a form for a promissory note secured by real property. Several websites, including www.lawdepot.com and www.uslegalforms.com, offer standard legal documents for a nominal price. Fill out the form, then record a trust deed on the property with the county recorder's office. Or you could hire an escrow or title company to help you.
Recording the loan helps to protect both the lender and the borrower and could help to circumvent family resentments. Also, if the borrower plans to count the interest payments as a tax deduction, it is critical to show the IRS that the transaction is legitimate.
* To ensure that the borrower qualifies for tax deductions, the person giving the loan must charge an interest rate no lower than a rate set by the federal government. If the rate is too low, the IRS will consider the interest income a gift to the borrower. The minimum rate, known as the Applicable Federal Rate, changes monthly and can be found at www.irs.gov. At the site's home page, search for the phrase "Applicable Federal Rate," then click on "Index of Applicable Federal Rates." Last week, the minimum rate that could be charged on a 30-year loan was 4.79%.
* With a private loan, the lending family member or friend can receive the interest income and pay taxes on it. Or the lender can opt to forgive a portion of the interest or the principal in the form of an annual gift. Tax law allows an individual to give a gift of up to $11,000 to another individual per year tax-free.
posted by burnmp3s at 1:01 PM on May 5, 2009
When my best friend and her husband bought a house, they had an arrangement with her parents that sounds a lot like what you're proposing. Her parents bought the place they wanted outright, then best friend and her husband paid mortgage payments to the parents.
Good aspects to it:
--all that interest money stays within the family;
--very favorable terms, more favorable than market rate;
--lots more flexibility w.r.t. payments than you'd have with a bank (i.e., if the check is late, they're probably not going to destroy your credit rating).
--steady income for the parents.
Bad aspects to it:
--friend felt like she'd never be out from under her parents' thumb (even though they were/are generally very wonderful people, she still felt less than fully independent);
--now that friend and her husband are getting divorced and the house may or may not have to go up for sale, her widowed mother's finances are also tangled up in the divorce, making a complicated situation feel even more complicated
--also related to the divorce, the more flexible/less businesslike nature of the arrangement means that it's been harder to make concrete plans about the disposition of the house (i.e., her husband wants to keep the house but can't afford it alone, and has harbored irrational hopes that some "arrangement" will be worked out--this would likely not be the case if the note holder was a financial institution).
No matter how it goes, good luck with the house purchase!
posted by Sublimity at 10:23 PM on May 5, 2009
Good aspects to it:
--all that interest money stays within the family;
--very favorable terms, more favorable than market rate;
--lots more flexibility w.r.t. payments than you'd have with a bank (i.e., if the check is late, they're probably not going to destroy your credit rating).
--steady income for the parents.
Bad aspects to it:
--friend felt like she'd never be out from under her parents' thumb (even though they were/are generally very wonderful people, she still felt less than fully independent);
--now that friend and her husband are getting divorced and the house may or may not have to go up for sale, her widowed mother's finances are also tangled up in the divorce, making a complicated situation feel even more complicated
--also related to the divorce, the more flexible/less businesslike nature of the arrangement means that it's been harder to make concrete plans about the disposition of the house (i.e., her husband wants to keep the house but can't afford it alone, and has harbored irrational hopes that some "arrangement" will be worked out--this would likely not be the case if the note holder was a financial institution).
No matter how it goes, good luck with the house purchase!
posted by Sublimity at 10:23 PM on May 5, 2009
Response by poster: Thanks for the great feedback, I'm still awaiting the specific details after family has spoken with attorneys and accountants. I'll post back how things go.
posted by peripatew at 2:21 PM on May 7, 2009
posted by peripatew at 2:21 PM on May 7, 2009
This thread is closed to new comments.
Make sure the contract spells out exactly which economic indicators you'll be using to determine whether (or when) this increase happens.
posted by chrisamiller at 12:28 PM on May 5, 2009