5 tips for doing a private mortgage
It's tough to find certificates of deposit that pay 2% a year. But if you're a bank lending to 30-year fixed-rate mortgage borrowers, you can earn 4%. At I Want a Better Mortgage, our specialists can help cut through the red tape and help you succeed in getting the loan you want.
Wouldn't it be great to be a bank?
Pros and cons
When Pittsburgh accountant and attorney James Lange bought his mother's house, he paid her half the purchase price over time, using what's often called a family or private mortgage. The transaction, he says, "worked out beautifully."
Yet he sounds a note of caution. "With this one, I've seen more problems than good situations," Mr. Lange warns. "If it's a choice between making a car payment and paying Dad, the kid will make the car payment, because Dad isn't going to foreclose."
Failing to pay is clearly the biggest potential problem—and it could have financial reverberations. If the child miss's payments, the parents will likely want to make it up to their other children, either by making gifts or adjusting their estate plan.
Even if the child pays on time, the deal may create family tension, perhaps because the parents start questioning the child's financial decisions or because the child fears their disapproval. On top of this, the child's regular mortgage payments won't help his or her credit score. To set up the private mortgage, you may need legal help—and the attorney involved could charge a hefty sum, given that this isn't your typical real-estate deal.
Set against these pitfalls are some key advantages. "It saves on closing costs and private mortgage insurance," notes Allan Roth, a financial planner in Colorado Springs, Colo. "I've set it up as a win-win, where the kid gets a low-cost mortgage and the parents get cash flow. But I've also done it as a wealth transfer, so you charge the lowest interest rate the government allows."
I have mentioned the notion of private mortgages to many folks, and the reactions are all over the place. Some think it's financially foolish. Others find the idea clever. Are you among those who are intrigued? Here are five tips:
You have to charge interest
To avoid tax headaches, you need to collect at least a minimum amount of interest, which is the IRS's "applicable federal rate."
You'll need a promissory note
This spells out the terms of the mortgage, including the interest rate and the repayment period.
You'll need a deed of trust
Also known as a mortgage or security deed, this establishes that the loan is secured by the property and the lender has the right to take the property back, should the borrower fail to pay. For your son or daughter to deduct the loan's interest payments, the deed of trust needs to be recorded with the appropriate local authority.
All this might sound complicated, but there's a four-year-old firm, National Family Mortgage, that will do the necessary paperwork for $725. The Waltham, Mass., company will also oversee payments for a fee of $15 a month and up, including providing monthly statements and annual tax reporting. "For a lot of families, it's all about keeping this relationship as business-like as possible," says National Family Mortgage's chief executive, Timothy Burke.
Get title insurance
Your child should talk to his or her attorney about getting title insurance, but you might save money by not bothering with a separate lender's policy, Mr. Burke says.
Think through the risks involved
As a rule, if your child couldn't qualify for a mortgage from a bank, you probably shouldn't be lending, either. Sure, there may be circumstances that you know about that perhaps a bank would be reluctant to consider. For instance, maybe your daughter is about to graduate and start a well-paying job.
You also shouldn't write a private mortgage if you can't afford to lose the money involved.
Pros and cons of private-mortgage loans
The problem for most borrowers in recent years hasn't been low mortgage rates, it has been the strict lending requirements imposed by most lenders. If you're having trouble qualifying for a conventional mortgage, a private-mortgage lender may be an option.
Private money funds, also known as "hard money," usually come from private investors or private lending companies who are willing to loan homebuyers money to purchase a specific property.
Homebuyers can often find these lenders by joining a real estate investment club in their area, Martin says, but these loans are most often secured by home investors. Unfortunately, not every homeowner will be successful getting money from a private lender.
Here are the pros and cons regarding private mortgage loans:
Pro: Easy to qualify
The loans could be a great option for homebuyers who are not able to qualify for a traditional mortgage because of less-than-perfect credit, debt or for self-employed individuals who can't always provide proof of a steady income.
The underwriting of the hard money loan is not so 'person' focused as it is 'property' focused. A person with poor credit can get a hard money loan if the project shows a likely profit."
Con: Short payback period
Private loans aren't paid back over 30 years like a traditional mortgage. Many private-money lenders expect the loan to be repaid within an extremely short time period, such as six to 12 months
Private lenders are often looking for a quick return for their money, and they usually aren't set up to service a loan for several years the way a typical mortgage company is.
For this reason alone, most homebuyers should look elsewhere for mortgages.
Pro: Great for 'flippers'
However, you might consider such a short repayment period if you plan to sell or "flip" the house within that timeframe, or expect to be able to qualify for a conventional refinance within a few months after acquiring the property.
If you plan to make extensive renovations in a short time period that will boost the value of the home, it is possible that you could sell or refinance the property fairly quickly.
Pro: Geared toward 'fixer-upper' properties
Homes that need extensive renovations generally can't qualify for conventional mortgages, no matter how good the borrower's credit is. In those cases, private money can play an important role, he says.
Some vacant homes may have been vandalized or someone may have stolen the plumbing. A private lender could step in and provide financing to get the house in sellable condition, and then "flip" the house.
Con: High interest rates
Interest rates are much higher with private-money lending than with conventional loans, Curtis says. In fact, mortgage rates are sometimes more than double typical 30-year mortgage rates, often 12 to 20 percent per year, he says.
Mortgage rates are so high because private lenders don't usually require perfect credit. Loans from private lenders are generally secured by the property in question, so it's usually not as important to the lender if the borrower has pristine credit.
Pro: Short approval process
If you have a house that you believe is a candidate for a private loan, the approval process often takes just a couple of weeks, as opposed to 30 to 45 days for a conventional loan.
For many borrowers, getting a loan that quick is a good tradeoff for higher interest rates. Private money lenders don't require a long drawn-out loan process like a conventional mortgage does.
If you have a house you want to rehab, and you feel that you could improve it enough to boost its worth in a short period of time that would allow you to pay off a private loan and replace it with a conventional refinance or sale, then getting a private loan is a viable option.
As long as you understand the caveats and do your research, it is possible to successfully secure a property without a conventional loan.
Having problems securing a mortgage? You're not alone. There are many reasons why someone may fall outside of the borrowing guidelines of institutional lenders. At iWantaBetterMortgage, we can help find the right lender for you.
Whether you have less than perfect credit, a reduced income, or a life event that has impacted your current financial situation, a private mortgage may be an option for you.
We'll sit down with you and discuss your current situation, and we'll look into financing options that may be suited to your needs. Star your search at I Want a Better Mortgage.