Yesterday I told you the story of when I borrowed money from my parents and how it really bothered me. I don’t think I could ever utilize my parents as my mortgage lender but as credit markets continue to tighten, more and more people are heading for the Bank of Mom and Dad for their own personalized mortgage deal.
Family mortgages can work as long as everyone fulfills their end of the bargain, timely payments are made, and the taxes and insurance premiums are paid. When you consider the minuscule returns on “safe” investments such as certificates of deposit or money market accounts, getting a 5% return on a mortgage backed by real estate can be appealing. Additionally, when you combine these type returns with the tight lending standards many young home buyers are facing, you begin to realize that there’s a need and a way to fill it. With many Baby Boomers now unwilling to risk their life savings in the stock market, financing a child or other family member’s mortgage could be an opportunity for a win-win situation.
I personally have some friends who, though the creation of a family trust, are able to offer mortgages to family members. They operate via a committee of 6 or 7 people who evaluate each applicant and then make a determination whether to offer a mortgage and how much. The original money came from the sale of a large business that a great-grandfather had started back in the 30’s. That money he made is still helping his family today. Great legacy, huh?
The roll of the IRS
Parents who finance a child’s home purchase can easily find their generosity in conflict with the mission of the Internal Revenue Service. Some of the possible problems:
A mortgage with far too generous terms
If the interest rate is less than the government’s applicable federal rate at the time of the loan, the IRS may want to have a meeting. Those rates apply only for loans of a certain duration (such as ten years) so it’s best to run anything like this by your accountant or tax advisor.
Gift taxes were instituted to prevent the wealthy from giving away their fortunes before they died. If a parent is thought to have gifted the mortgage proceeds, the IRS won’t be happy. It’s best to keep all paperwork handy and to insure that the mortgage really is a mortgage and is being repaid.
The potential for missed tax deductions
Anyone using the Bank of Mom and Dad for a mortgage should make certain their mortgage is registered with a government authority and filed at the courthouse in their county or parish. Non-registered mortgages are not eligible for the interest deductions and subsequent tax breaks that a regular mortgage is so register that mortgage! A reputable attorney should be able to help you complete this step.
The risks of a family mortgage
Obviously the biggest risk is of default and that’s a huge concern for parents. Many times one parent will be gung-ho and the other … not so much. The concern is that a parent will fund a mortgage only to have to eventually evict their own child or risk losing their life’s savings. That isn’t a fun thing to have to consider as a parent.
Another risk is the loss of financial flexibility for the parent. A mortgage isn’t exactly a liquid investment and should another more profitable or more appealing investment opportunity come along, the parent is generally stuck.
What about you? Would you consider lending your child $250,000 for a mortgage or even $50,000 for their down payment? Would you consider borrowing that amount from YOUR parents? I wouldn’t want to be on either end of that deal, but for many people a family mortgage is just the ticket to get Mom and Dad a reasonable rate of return and to get Junior into that house.