Home loans from family or friends can be good for you as a borrower, but asking for money can be tricky, considering the large sum involved. Don’t enter into a private home loan lightly — it’s a legal contract, and you don’t want friction with Aunt Martha at the holidays. However, if you plan ahead, structure the loan carefully, and explain how the loan can work to the lender’s advantage, everyone can be more comfortable about the arrangement.
How to Ask Family or Friends for a Loan
When you approach your friend or family member for a home loan, have a plan. Thomas Fox, community outreach director at Cambridge Credit Counseling, recommends treating a private home loan as you 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.
Private Home Loans Are Similar to Traditional Mortgages
Private home loans, also called private mortgages or intrafamily mortgages, aren’t that different from a loan from a bank or a credit union. As with 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.
- The promissory note should establish the amount loaned and the interest rate, as well as the repayment dates and frequency.
- The borrower and lender draw up a mortgage (also called a deed of trust) giving the lender the right to foreclose on the property if the borrower fails to stick to the repayment plan.
- The lender holds a lien on the mortgaged property.
The arrangement legally protects both lender and you the borrower. 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 work out to the lender’s advantage.
- Setting your own repayment terms. You can determine a repayment schedule that works best for you — monthly, semiweekly 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 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 your interest rate is lower than that of a bank loan, the rate could be higher than what the lender earns through a savings account or investments.
- Regular income. With the structure provided by your promissory note’s repayment plan, the lender will know exactly when to expect your payments and how much they will be.
Missing Payments With a Family Loan
Unforeseen life twists happen: You might lose your job or have medical bills that pile up. With a family member of friend, as with any lender, discuss the situation — dodging Aunt Martha’s calls aren’t the way to go. The options are the same: Loan modification can include lowering payments in exchange for a longer loan term, temporarily freezing payments or maybe letting some payments slide.
Tasha Schroeder wrote this article.