Intrafamily Mortgages - Paying Your Family Instead of a Bank

Feature: Intrafamily Mortgages – Paying Your Family Instead of a Bank

(Image: Chandra Webb)

An Investment Vehicle for the Lender

Intrafamily loans not only provide parents like Hezekiah a way to support children or other family members who prefer to avoid the checks, balances, and interest rates, they would be subjected to from traditional lenders, but they can also be a sound investment.

In addition to the monthly mortgage payment, which is determined largely by the size of the loan, the lender is getting a rate of return on the loan that is higher than interest rates they would earn in investments such as money markets and CDs. “Our average rate in June was 2.91%. This can be a good investment option for parents looking to reduce some of the risk in their retirement savings and take money out of stocks, while still earning a return,” says Burke.

Interest rates are decided between the borrower and the lender, but they must be at least as high as the Internal Revenue Services’ Applicable Federal Rate, (AFR), which the IRS publishes each month as a guideline for assigned interest charges. The current AFR for loans that are nine years or more is 2.82%. It’s 1.82% for loans between two and nine years, and 0.48% for loans that are less than two years.

“I have good credit, but I do feel more secure knowing the loan is with my father, and the rates are better than I could find at a bank,” says Chandra.  “I know what my payments will be each month, and I know that my most important asset is in the hands of someone who cares about me,” she adds.

Costs and Benefits of Intrafamily Loans

National Family Mortgage charged the Webb’s a fee of $875 to structure the mortgage, as they do for all mortgages between $100,000 and $200,000. The fee rises to $1,075 for loans that are $300,000 to $500,000 and to $1,725 for those in the $500,000 to $1 million range. Loans that are more than $1 million cost $2,100.

The company also charges $15 a month for its electronic payment service, which Burke says is the most popular payment option. Most payments are deducted on the first of the month. The borrower and lender also get a monthly statement and formal tax documents:  A 1098 for the borrower and a 1099 for the lender.

The home itself is used as collateral for the loans, and liens are in place, although Burke says he has never had to enforce one. In addition, since the loan is secured by a registered mortgage, the homeowner can deduct interest payments from their taxes.

Know Your Customer

Intrafamily mortgages can become ‘houses of cards’ if the borrower is unable to honor their monthly financial commitment. In addition, doing financial transactions with family members can be risky business.

“The complexity of family relationships, combined with the emotional baggage and beliefs we hold around money, can make for a volatile combination,” says Rick Kahler, founder and president of Kahler Financial Group.

Kahler says one of the best features of intrafamily mortgages is that they can take a lot of the emotion and drama out of the ‘family money dynamic.’ “It is essential to execute formal documents, such as mortgages or contracts for deed. This emphasizes that the loan is a real transaction and a legally enforceable agreement,” he says.

As Kahler and other financial advisers point out, however, when it comes to doing any lending to a family member, keep in mind that being a lender of ‘last resort’ to someone who is in financial chaos is never a good idea.

3 Questions to ask before you enter into an intrafamily mortgage

Can you afford to make the loan? Always make sure your overall budgetary needs are met, and that you’re on track to meet your retirement savings goals before you even consider stepping into someone else’s financial life.

Can you and the borrower communicate directly and honestly? An inability to have an honest discussion about money is at the heart of many family disputes. Be honest with yourself about the level of honest communication you have with the borrower.  Chandra says the fact that she and her father always had open and honest discussions about finances played a big role in how smoothly the transaction went.

What are you willing to do if the borrower fails to make payments? Not only is it important to pay attention to what the financial ramifications would be to your budget if the borrower missed a payment, but also consider what it would do to your relationship?  Pay attention to the emotions that come up as you think about making the loan. Discuss this with the borrower before you make your decision, and be sure to ask them to give you a designated amount of advance notice if they think they will miss a payment.