Bob Hope once said, "A bank is a place that will lend you money if you can prove that you don't need it." Maybe that explains why more and more homebuyers are turning to loved ones, and even more distant members of their circle, for help with financing. If done right, tapping the "Bank of Family and Friends" can be financially lucrative for both you and the person lending you the money. You get the cash you need, they earn interest at a rate equal to or even higher than they could have gotten elsewhere; everyone wins.
Commonly called a private home loan, a private mortgage, or an intrafamily mortgage, such a loan is not much different than one you'd get from a bank, credit union, or other institutional lender. As with an institutional loan, you'd normally sign a contract and establish a schedule of monthly repayments with interest. Your private lender will hold a lien on your property and have the legal right to demand full payment on the outstanding balance if you fall behind in making payments.
(Note, however, that unlike in the past, you'll probably need to find a private lender to fund you the entire amount of the loan. Trying to combine a family-and-friend loan with a traditional bank loan can lead to the bank refusing to go forward, if you appear to be taking on more debt than you can handle.)
Your private lender can even foreclose if you default on the loan. Few would go so far, but it's important to give them this right, so that if you get into financial trouble and another lender forecloses on you, your private lender won't be left in the cold.
Rest assured, you have legal rights as well. Your parents couldn't foreclose on your house just because you arrive late for their 50th wedding anniversary, and your best friend couldn't demand an early payoff in order to buy a new car.
By turning to the bank of mom and dad, your favorite aunt or uncle, your in-laws, a brother or sister, or even your best friend or business colleague, you might gain the following:
Whether it's a relative or a friend, your private lender stands to gain in a number of ways, such as:
Once your private lender has agreed to loan you money to finance your home purchase, you'll want to handle the transaction almost as a bank would. This includes drafting and signing a written promissory note and supporting mortgage documents. It's a good idea, although not required, to draft a written repayment schedule as well.
It's wise to get professional or legal help with this, particular if the loan won't be between immediate family members. Some family loans might fall under the federal Dodd-Frank Act, which is implemented by the Consumer Financial Protection Bureau and governs mortgage lenders.
With any luck, your income will remain stable, and you'll be organized about making payments until either the loan is paid off or you can refinance with a traditional lender. However, unforeseen circumstances might arise, causing you to run short on cash. Whatever the problem, if it's a legitimate cause for you to be late with your payment, discuss it with your lender. Get in touch as soon as possible, and by all means before the payment comes due. Your lender will likely appreciate your honesty and might help by lowering your payments, temporarily freezing them, or even forgiving some payments altogether.
That's the beauty of an intrafamily mortgage. Repayment is much more flexible than with a bank. Just make sure that you don't abuse your lender's trust. Save special requests for the true emergencies.
For a comprehensive guide to help you get the right house at the right price, get Nolo's Essential Guide to Buying Your First Home, by Ilona Bray, Ann O'Connell, and Marcia Stewart (Nolo).