Borrowing Down Payment from Family and Friends
Asking a friend or family member for a home loan can be tricky, considering the large sum of money involved. Entering into a private home loan isn’t a decision to make lightly—after all, you’ll be seeing Aunt Martha at the holidays for years to come—but your loved one might be more likely to make the loan if you explain how it will also work to his or her advantage.
How to ask for the loan
When you approach your friend or family member for a home loan, have a plan in mind.
Thomas Fox, community outreach director at Cambridge Credit Counseling, told bankrate.com readers that borrowers should approach a private home loan the same way they would a mortgage from a bank.
“Borrowers should be realistic about what a practical repayment plan would be and not try to borrow more than they can repay. You have to treat it the same as any kind of loan and be realistic,” he says.
If this approach seems businesslike, that’s because it is. When you create a legally binding loan contract, even your mother can take you to court for missed payments—and she can win.
How private home loans are similar to traditional ones
Private home loans, also called private mortgages or intrafamily mortgages, aren’t all that different from a loan from a bank or credit union. Like institutional loans, with private home loans:
- Both lender and borrower sign a promissory note (also known as a mortgage note) stating the terms of the agreement.
- Your promissory note should establish the amount loaned and the interest rate, as well as the repayment dates and frequency.
- You will draw up a mortgage (also called a deed of trust). This document gives the lender the right to foreclose on the property if you fail to stick to the repayment plan.
- The lender holds a lien on the mortgaged property.
The arrangement legally protects the borrower as well. The lender may not foreclose on your house due to a family disagreement and can’t request repayment in full because of other financial needs. So if Aunt Martha wants to go on a cruise, she can’t demand that you foot the bill as long as you’ve been sticking to the agreed-upon repayment schedule.
Private home loans benefit borrowers
When you borrow from a friend or family member, you benefit in several ways:
- Better interest rates. You can negotiate with your lender to determine the interest rate that works best for you. Even if that rate is lower than what you’d pay for a loan from the bank, it can still work out to the lender’s advantage – more on that below.
- Setting your own repayment terms. When you and Aunt Martha make a contract, you can determine which repayment schedule works best for you— monthly, semi-weekly or any other. Don’t take advantage of your lender’s generosity, though: You are still legally obligated to make payments as stated in your promissory note.
- Federal tax deductions. With a private home loan, you can still take the same tax deductions that you would with an institutional loan.
Private home loans benefit lenders
Lenders also receive benefits in a private home loan:
- Better interest rates. Even if you and Aunt Martha agree on an interest rate that is lower than what is offered through an institutional loan, she can still come out ahead. The rate you determine could still be higher than what she earns through a savings account or other investments.
- Regular income. With the structure provided by your promissory note’s repayment plan, Aunt Martha will know exactly when to expect your payments and how much they will be.
Missing payments with a family loan
No matter who loans the money, Aunt Martha, a bank or credit union, sometimes unforeseen life twists happen. You might lose your job or have medical bills that pile up. As with any lender, discuss the situation with the family member who loaned you the money. The options are the same as other lenders: loan modification can include lowering payments in exchange for a longer loan term, temporarily freezing payments or maybe letting some payments slide. However, dodging Aunt Martha’s calls aren’t the way to go!