When my husband and I decided to buy a 1-acre lot in Washington, DC, and build our dream home, we considered getting a mortgage the way most people do: through a bank. Instead, we tapped into a far less traditional source.
The backstory: When my father-in-law died in 1991, he left his wife of 50 years a fully paid-off house in Florida and about $300,000 in retirement savings. The intention and plan was that the interest she'd glean off her investments would keep her afloat, but no such luck. Interest rates on her CDs and federal Treasury notes dropped to record lows, hovering around 1%.
Meanwhile, my husband and I saw that the interest rates on mortgages to fund our own property plans were as high as 5%, and came with hefty closing fees. That's when the lightbulb went on: Why not borrow money from my husband's mom, then pay her back at the rates we would pay a bank? Not only would this boost her income stream, it would enable us to avoid closing costs -- and also sidestep the hassles and paperwork of a bank loan. It seemed like a win-win.
So we made her an offer, which she accepted -- and Mom has been serving as mortgage central for us ever since. Over the years, she's given us easy access to capital that's helped us build our own house, buy a vacation place, and dabble in real estate investment properties. With each new deal, my mother-in-law held the mortgage and received anywhere from 4% to 9% return on her money.
This family arrangement is hardly unusual. In an era when home financing is scarce, asking Mom and Dad for a home loan is a growing trend. While nobody keeps numbers on how many parents actually hold mortgages on their kids' homes, Tim Burke, founder of National Family Mortgage, which structures and manages family home loans, estimates that the number could be as large as 10% of all first-time buyers.
Advantages of family home loans
Family loans come with the following perks for all parties:
- They allow first-time buyers with little credit history, or older children with less-than-stellar credit, to obtain financing.
- They let borrowers bid on hot properties without a financing contingency, which can knock them out of the game against an all-cash buyer.
- Reduced mortgage fees. When you borrow from the Bank of Mom & Dad, you won't pay for an appraisal, points, application fees, or doc prep fees. So you could save thousands on the price of a house.
- Give parents a steady income stream that often is several percentage points higher than rates on safe, steady income investments. We continue to pay Mom 5% on a mortgage even though we could refinance the property for 3.75%. It would save us money, but we don't want to reduce Mom's income.
- It keeps money in the family. And family rules, right?
How to structure family home loans
Keep in mind, getting a mortgage from your parents is very different from receiving a gift. Gifts are exactly that -- a present that shouldn't be paid back (and don't even try to sneak this by the IRS). To qualify as an actual "loan," you must have a contract written up by a lawyer and register the loan with the state government.
While the interest rate is up to the parties involved, it must at minimum be at the level of the applicable federal rates (typically about 1% lower than the going rate). And while hiring a real estate lawyer to draw up the paperwork is a headache, it also means you reap the benefits: As with a bank-held loan, you can deduct the mortgage interest you pay on your tax returns.
Mom and pop mortgages aren't for everybody
My husband and I would rather eat dog food than not send Mom her monthly mortgage check (and thankfully we haven't had to resort to these measures). And that's a large part of the reason this arrangement works. But if the borrower doesn't make timely payments, a major strain could (and almost certainly will) develop within the family.
So family mortgages aren't for everyone, and are probably a bad idea if the borrowers already have financial problems they can't handle. Odds are, a mortgage from Mom won't fix this and may only make things worse all round. And pretty much the last thing most moms and dads want to do is foreclose on their kid's house -- or go through the hassle of restructuring a loan.
But don't discount the personal side of the equation. Family mortgages are also a bad idea if your parents are already too entangled in your life in a smothering, controlling way, or you suspect the mortgage comes with strings attached or hidden agendas.
Even though we get along well with Mom, our financial relationship has not always been smooth sailing. When the economy tanked in 2008, she panicked and tried to call in her loans. Awkward!
But we worked it out, as solid families do. We told her to relax and assured her that her money was safe. And it was. Through thick and thin, it's turned out to be a great deal for both sides. Because who doesn't love helping out a family member in need?
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