Are you thinking about making a private agreement to acquire a house loan for yourself or a loved one? A few simple principles will ensure that your financial arrangement runs successfully for both sides – the borrower and the creditor. We’ve got five pointers on how to make a private mortgage work.
What Exactly Is a Private Mortgage?
Private mortgage insurance is perhaps more recognizable to you than the concept of a private mortgage. It is not a standard method of financing a property purchase, but it does occur.
Private mortgages are those that are not obtained from a licensed mortgage broker or provider. Instead, money is lent to you by friends, family, acquaintances, corporations, or other private sources to help you purchase a property.
Tip 1: Document everything.
Even if it’s an intra-family loan, it’s to your best advantage to formalize it. You should document your mortgage agreement with a promissory note (a legal document that details who owes whom and how much) and register the mortgage loan and deed with the IRS and local authorities. You may need the assistance of a lawyer and a qualified public accountant (CPA) to ensure that everything is documented correctly.
You should ensure that you have a mortgage deed that secures the loan. If the borrower defaults or dies, the lender will be able to seize possession of the property. If this is not done, the property may return to the borrower’s other creditors, leaving the lender out in the cold.
Tip #2: Determine an Interest Rate
Although you may believe that a private or family mortgage should be interest-free, all parties should impose some interest. The lender will be more likely to outperform inflation, while the borrower will benefit from tax breaks.
To qualify for the home mortgage interest deduction (an essential consideration in the rent vs. buy choice), the lender must charge an interest rate equal to or more than the IRS Applicable Federal Rate. This (low) rate changes depending on whether the loan is for a short, medium, or long period. If you are the lender of a private mortgage, remember to record the loan interest as income when it comes time to file your taxes.
Tip 3: Talk about contingencies.
Borrowers and lenders should address potential contingencies that could affect the lending agreement before committing to a private mortgage. What happens if the borrower faces financial difficulties and fails to make a payment? How are you going to restructure the loan to avoid a default? The services of an attorney and a tax preparer might help plan for contingencies. Private companies, such as National Family Mortgage, LLC, also provide services to assist the parties in a private mortgage in making the most loan agreement.
Tip 4: Maintain Civility
Remember that before you had a financial relationship with your lender or borrower, you had a personal relationship. If matters become tense, seek the assistance of a mediator before your mortgage becomes a sticking point. If you don’t think your relationship can withstand the strain of a large-scale financial entanglement, forgo the family mortgage and instead consider a financial gift agreement. You don’t want to be the family that disputes over money during Thanksgiving dinner.
Tip 5: Obtain Credit
If you choose a private mortgage rather than a traditional mortgage, you may have difficulty convincing credit reporting companies to include your mortgage payments in your credit score. They have the option to do so at their discretion (and for a fee). Your best hope is to provide copies of your family mortgage agreement and regular mortgage payments to each bureau, along with a letter requesting that your payment history be included on your credit report.
Arranging a mortgage loan with a trustworthy friend or family member might be an excellent option to finance a property without paying a mediator. However, before making such a significant financial commitment, it is critical to ensure that it is in your best interests – both financially and emotionally.
Advice on Purchasing a Home
You may discover that obtaining a private mortgage is not in your best interests. If things don’t work out, you can always take the customary route. Interest rates are lower than in previous decades, and many institutions provide a variety of term lengths.
Reading reviews might also help you learn about how other mortgage lenders work. It’s good to have backup plans in case your private mortgage falls through.
Before making a large purchase, such as a home, please consult with a financial expert about how it will affect your financial plan and budget.