Don't Mortgage Your Family's Goodwill
03/15/2012 6:00 am EST
Focus: REAL ESTATE
Saving your kids from the pain of a bank mortgage can be one of the longest-lasting gifts you can give...but there are enormous personal risks in addition to the financial ones. However, one company offers a way to hopefully take the hard feelings out of the process, writes MoneyShow personal finance expert Terry Savage.
Picture this: Mom and Dad have lots of savings earning a fraction of 1% in a bank CD. Daughter and son-in-law don’t have enough credit history or a large enough payment to get a mortgage, at least not at a decent rate.
Is this a perfect match—or the recipe for a perfect disaster?
Making a mortgage loan to a family member can be a win-win deal—or it can breed resentment and arguments that last for years. That’s why it’s so important to do it right. Here’s how to make that happen.
First, you have to view this as a business deal. I’m assuming your adult children have good credit, and sincere intentions to repay the loan. Otherwise, you might someday have to be chasing them for monthly payments, or even consider foreclosing on the house in which your grandchildren live! You don’t want to go down that path if there’s doubt in your mind.
Earning interest on the mortgage is probably a better deal for you, assuming you have plenty of savings, than simply offering to co-sign on a bank loan. But keep in mind that this loan is truly illiquid. Don’t do it if you foresee a need for the cash before the loan matures.
If you’re still ready to make this kind of deal, it’s extremely important that the arrangement be properly documented to ensure that the tax benefits can be taken, and so there will be no doubt that this is a business deal, not an intra-family gift. There’s an easy way to do that.
NationalFamilyMortgage.com specializes in handling the entire documentation and registration process for inter-family mortgage loans. Founder and CEO Tim Burke says NFM has structured more than $27 million in mortgage loans, resulting in more than $14 million in interest remaining “in the family.”
Average interest rate on the loans is 3.35%, and average term is 22 years. But each loan can be set up with its own unique terms, within IRS guidelines for appropriate rates.
The online process is simple. Once you’ve filled in the information, including address, terms of the loan, and contact information, NFM gets the legal description of the property and draws up the note and mortgage document. Then the lender (typically the parent) disburses the money—either through an attorney or directly to the borrower.
NFM does not handle the disbursement, but the company does provide a monthly service, creating an automatic debit for the monthly payment that then goes directly into the lender’s bank account.
The cost is $15 per month, and includes a year-end 1099 interest report for the lender and a 1098 form for the borrower, documenting interest paid on the mortgage loan. Or the parties can agree to pay each other directly, using the loan amortization schedule that is part of the package to determine at year end how much interest was paid or received.
Why go through this process when you could just sit down at the kitchen table and draw up a loan document?
Burke stresses that the IRS rules say the borrower can only deduct the mortgage interest if the loan is properly registered on the title and secured as a mortgage. That’s what makes the $599 fee for creating the mortgage document worth the effort.
Plus, having a the servicing record of on-time payments will make it easier to refinance at some time in the future.
Most important, this documentation assures there will never be any misunderstanding between family members—or the IRS—about who owes what and when it must be paid. That’s the Savage Truth.