Mortgage interest rates have been at historic lows the past few years, and this had led to unprecedented numbers of homes being bought and sold at incredibly high prices, especially in states like New Jersey. Borrowers who reach out to relatives can often get even lower interest rates, and there are companies that specialize in these kinds of private mortgage loans. Oftentimes parents will lend money to their adult children, but many grandparents, siblings, aunts, and uncles chip in too because this way, the money stays in the family. How are these family home loans done, and what are the pros and cons?
The Family Home Loan Process
These loans can have more flexible terms than traditional mortgages and are generally designed to suit borrower and lender needs more closely. The family member will be considered a private lender, and specific paperwork will need to be completed. The first is a mortgage (promissory) note, a binding document signed by both parties. These are agreements that the loan will be paid back under certain terms, such as the amount of time, interest rate, payment dates and of course, the loan principal. Promissory notes also include any penalties that may be incurred for non-payments or late payments.
A mortgage document or deed of trust is legally binding and is made to secure the promissory note. It will give the lender legal authority to foreclose if the borrower does not pay off all the loan by the agreed-to date and can also impose interest and fees on the money due. Mortgage documents specify the property’s recognized owner, a legal description of the property being mortgaged, regulations to keep the property in a certain condition, and the borrower’s responsibility to pay off the mortgage and maintain insurance. There may also be rules pertaining to an early payoff and a repayment schedule.
Private loans must close just like ones obtained from other lenders like banks and mortgage companies. The paperwork can be complicated, and both parties need to protect themselves – one never knows what the future holds in terms of family relationships and finances. It is wise to consult with an insurance lawyer who is familiar with the process and could be well worth the time and effort involved. People who are familiar with the ins and outs of buying and selling real estate and insurance concerns could end up with problems that they are not equipped to solve when they do not seek professional advice.
How Can I Benefit from a Family Loan?
One of the best parts about securing a private loan from a family member is that the lending criteria is not usually as stringent as with other lenders. This means that poor credit might not be a problem. These kinds of loans can also foster a sense of good will, as helping family members can be very rewarding. Family lenders may also be likely to offer lower interest rates, saving the borrower thousands and thousands of dollars over time.
Besides that, the family member lending the funds can earn interest, which can help them as well. Some relatives will not charge interest at all, which can be helpful for struggling children, grandchildren, and so forth. The repayment terms can also be more flexible, with a longer payoff period and less penalties when payments are made on time. There is also less risk for lending scams, since some companies target people who have poor credit.
What Are the Downsides of Borrowing Money from Relatives?
The first downside of borrowing money from family members is a breakdown in family relations. When loan agreements are not adhered to, there can be arguments that lead to bad blood. No one wants to see their relationships break down, so this is one of the most important things to consider when thinking about family loans. Tax implications can also come into play, which can cause tempers to flare. Lenders may have to pay interest on income they earn from loans, plus income that is not earned if they provide below-market rates. In some cases, the IRS could consider the loan to be a gift and the lender might need to pay gift taxes – this is also something that an insurance attorney could help with.
Private loans like these do not boost credit ratings, even when borrowers make every single payment on time. This could be a roadblock for people who need to increase these ratings. Lenders can also have problems getting reimbursed for their losses when the family member defaults. These are informal agreements, making them harder to enforce. Again, the IRS and courts often view these loans as gifts, which makes things more complicated.
Are There Other Loan Alternatives for Home Buyers?
Yes, and if you do not want to ask a relative to loan you the money, there is the option of asking them to co-sign. This still involves a level of risk, since if you default, your relative will be responsible. If they do not make good on the loan at that time, their credit rating will likely take a hit. The relative could gift you the funds instead and can offer as much as $15,000 per individual/$30,000 for a couple without generating any gift taxes.
Some borrowers decide to add family members as authorized users on their credit cards. The pros of doing this include boosting credit scores and earning more rewards. Keep in mind that non-payments will lead to high interest charges and additional fees, though. People who need to get loans to start up or expand businesses can also look into Small Business Association (SBA) loans, which assist entrepreneurs. As with other kinds of loans, there is an application process with varying requirements for applicants.
Tips for Setting up Family Loans
Before a family member lends a significant a mount of money to a relative, it is important to do a financial check-up. Being generous is all well and good, but the lending relative should only provide money that is within their means. The tax implications should also be researched, since an unexpected charge could be a big problem if the lender cannot afford it.
When loans are for $10,000 or more, parents must charge interest to their children, according to the default IRS rule. Yet even if the amount is less, it makes sense to formalize the loan in writing to prevent problems down the road. The IRS investigates these things and has been known to reclassify loans as gifts that can incur taxes.
The New Jersey Estate Lawyers at Herold Law, P.A. Help Relatives Set up Private Loans at Lower Interest Rates
It is important to consider all the pros and cons of arranging a family loan, and larger amounts come with more responsibilities. For a confidential consultation on these kinds of loans, contact the New Jersey estate lawyers at Herold Law, P.A. Call us at 908-647-1022 or complete our online form. From our Warren, New Jersey offices, we serve clients in Warren and Plainfield.