- May 3, 2024
- Posted by: legaleseblogger
- Category: Related News
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Hello Personal Finance,
Fiancé and I are in the midst of planning to purchase a new home, and we are currently faced with the dilemma of high interest rates, hovering around 7%. In light of this, my parents have gracefully extended an offer to assist us with the down payment. However, due to gifting restrictions, they have proposed a unique solution: acting as the lender for our mortgage instead. Initially, our plan was to put down between 300-450k on a house in a high-cost-of-living area, with the remainder covered by a mortgage of around 600k. However, with my parents stepping in as the lenders, they have assured us that the interest rates would be significantly lower than the market rate (although not at 0% since it is not a gift). At first glance, this seems like a win-win scenario for all parties involved. We secure our dream home, my parents earn a modest amount of interest (albeit less than what they could potentially gain in the market), and our offer would appear as a cash offer, potentially giving us a competitive edge in the real estate market. Despite the seemingly advantageous nature of this arrangement, there is a lingering sense of uncertainty. While my parents are trustworthy and financially stable individuals who have explicitly stated their intentions of supporting us and shaping our financial future, there is a nagging feeling that we may be overlooking something crucial. Seeking to approach this situation with caution, we intend to enlist the expertise of legal professionals and financial advisors to ensure that every aspect of this transaction is handled appropriately. In the midst of this decision-making process, we are eager to hear the insights and perspectives of the /r PF community.
Thank you for your guidance and advice.
Warm regards,
Gigglenought
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It’s fine to use your parents as the “bank” and not too difficult. Just make sure you are all in agreement and have some paper work on it from the start. A fair rate would be halfway between what you would get with a mortgage and what they could get on a 30 year treasury (and makes the rate easy to justify to avoid gifting rules).
also if they are collecting interest on it I’m pretty sure they are still supposed to file the interest as taxable income. This is their problem more than yours, but they should ask someone about that.
I’m sure if they are smart they’ll draw up a Contract and that’s the RIGHT way to do it. Verbal Agreements are NEVER ok. Been there and done that. Be Grateful they have that kind of cash on hand and take the offer. Family with money and a good heart and brains is the best thing you could have.
I’ve had similar help in my life and a Contract even with blood relatives is a MUST. My dollar amounts were less than yours but everything worked out great as long as you stick to the contract and keep working hard.
Congrats!
What gifting restrictions are you facing?
on a purely emotional level, be sure you trust your folks not to hold this over your head/manipulate you with their generosity.
There are set minimum rates: https://www.irs.gov/applicable-federal-rates
I did this. I think it is great. Win-win. My family has never attached emotional rules or obligations to money and I would think that would be the downside. The other upside is you can structure and restructure as you wish. For example make it interest only for a few years and then redo the line to lower interest rates when they come down. Much more flexibility. And you get the same tax perks as bank loan. You will also be able to make an all cash offer since no bank is involved and no fees.
Years ago, I had a colleague that did this. His parents essentially bought a house outright and were the “bank”. The problem he had was the market dropped, and he lost his job and the only option in his field was a two hour commute away. It was a situation where he would have done a short sale if the house was bank owned, but he felt guilty essentially doing that to his parents, and leave them holding the bag for a house they had lost money on.
So he commuted. And was soooo miserable.
[https://old.reddit.com/r/RealEstate/comments/1cf5vm7/please_poke_holes_in_my_fianc%C3%A9e_and_mys_plan_with/](https://old.reddit.com/r/RealEstate/comments/1cf5vm7/please_poke_holes_in_my_fianc%C3%A9e_and_mys_plan_with/)
similar thread?
>I currently see no downside to this.
what is the upside exactly, how are they helping you in any way here?
>but due to gifting restrictions
people in the networth range to worry about lifetime gift tax exemption are people who should not be nickle and diming you over a rounding error on taxes.
https://www.schwab.com/learn/story/family-loans-should-you-lend-it-or-give-it-away is a decent read on some of the things to consider. It’s a couple of years out of date so things like the gift reporting thresholds and mandatory minimum interest rates for loans to family members are out of date, but it’s a good overview.
For the loan to be considered a loan (and not a gift in the eyes of the IRS), there must be some interest charged on the family loan.
If the interest charged is below the AFR, then they (your parents) will be receiving ‘imputed interest’ on the difference between the two rates – interest they never received but will be taxed on.
Also, any difference between what your family charges you in interest and the AFR will be considered a gift (annual gift exclusion for this year is $18k).
https://www.hrmml.com/wp-content/uploads/2013/10/client_alert_-_intra_family_loans.pdf
If your parents have enough money to pay cash for a million dollar home, I’m willing to bet they have a lawyer or CPA who can figure this out. Ask them.
My dad loaned me the money to purchase a house. 18 months later he passed away. I ended up needing to get a regular mortgage anyway so that I could repay the estate so that my brothers would be able to get their portions of the estate in a timely manner.
I heard from a lender that there are issues with lending money below market rates and that the IRS can step into tax your family for interest that they could have collected. [This](https://www.schwab.com/learn/story/family-loans-should-you-lend-it-or-give-it-away) article discusses it.
The tax implication for your parents may be something they would need to consider as well, because interest you pay would likely be taxable income for them anyway.
The borrower is always slave to the lender. You do NOT want to be beholden to your family for finances. That is the quickest way to stop talking to each other.
We did this with my husbands parents. My husband is in medical residency and we were having a hard time getting an offer accepted without a cash offer so they offered to be our lender so we could get into a house. We have a 30 year note with them. We have a clear contract and amortization schedule. Our interest rate was the going interest rate at the time which was only 3% and that seemed fair for both parties. It’s worked out well for us for the past 3 years. I guess the only difference is that we’ve always known it was going to be a 3 year agreement until my husband was done with training and then sell when we move states. They’ve been so supportive and we haven’t felt weird about the arrangement at all. I think it could work well if they’re not the kind of people to use it against you. They transferred the money to the title company but my husband and I are the ones on the title and deed. My mother in law is a financial advisor with experience with clients doing mortgages for their children so I don’t know exactly what the tax implications are because she took care of all of that but as far as I know it’s not considered a gift.
(they said it cant be 0 as its not a gift but its a much lower rate)
Its not going to be as low as you think, the law on this is here for what are called Intra-Family Rates:
https://www.irs.gov/pub/irs-drop/rr-24-09.pdf
its generally around 2 points lower than the prevailing public rate. So you could expect around 6-7 right now for a 30 year loan.
So, the interest rate will have to be the minimum imputed IRS rate for long term loans during the month you sell the property. Currently, for the month of May, 2024, the long term (more than 9 years) rate is 4.55%. That is the minimum amount the IRS will tax them on, regardless of whether they receive it or not.
The lawyer will then draw up the closing papers, Note, and mortgage and file everything just as they would for a bank loan. You would likely not have an escrow account unless your parents required it, meaning you would pay your taxes and insurance yourself. Your insurance should list your parents as the Mortgagee just as they would a bank.
Some tips – because you won’t have a bank’s computer calculating extra payments for you, it is often easier to just make the payment EXACTLY – not rounding up or anything, to keep to the amortization schedule. That will make it easier for both sides to calculate the interest paid for tax purposes.
As long as the paperwork is done properly – there is no downside to this.
Seek an attorney’s advice and get a legal agreement in place. It shouldn’t cost much.
Just make sure that this is strictly a financial agreement and there is no “Well I helped you pay for the house, so you owe me this…..” outside of the actual money you owe them.
I wouldn’t recommend it. Do you really want your parents questioning every financial decision you make for the next two decades?
In addition to contractually getting this spelled out with your parents, get a prenup if you’re not already in that process. Your fiance stands to lose the most in this situation if for whatever reason your relationship doesn’t work out.
Other than all the legal stuff, I would want to be sure they weren’t relying on the payments for their retirement, and I’d want spelled out in the contract what happens to the house if you stop paying. I would not accept them being on the deed.
If you have siblings who might also inherit from them, it’s worth talking through how this might effect inheritance.
Make sure you’ve thought through the realistic worst case scenario here. From an emotional standpoint, that would either be your parents hitting a situation where they needed access to that money, or from a more practical standpoint, dementia kicking in and them not being clear on the terms of the deal.
Sorry for being cynical but the thing you’re missing is that Redditors mostly don’t trust their family and you’ve heard a thousand times on here it’s a bad idea.
I trust my family and would do this and will probably do this for my kids in the future.
Do you have siblings? My concern would mainly be family drama if this gift/loan is perceived as inequitable across the family.
>They arent the type to come after us and have made it clear
I’ve seen similar deals go without any hiccup BUT it’s always fine at first for any relationship. You wouldn’t start a business with someone saying that they’ll put more upfront to tie you with it and to have more control later on. Well maybe you like to be tied but let’s keep the discussion about loan/investment. Please, consider that as a business deal and have the proper paperwork as you would do with a bank and as the parents would do with a third party.
The problems arise if you end up in a “what if” situation. What if you skip payment(s)? What if they require emergency funds? What if you want to sell? What if you have an hostile separation because you cheated and they loved your Fiancé? Will you “renew” in 5 years? Then what about current and future rates? What if they don’t like the renovation you want to make? Can they pull back the loan if you don’t baptize the children?
Therefore, the idea to define the loan as a commercial transaction without conferring undue powers on one party or the other that it would not have with a third party. It’s also to cover some exceptional situations that might arise as life isn’t linear. You do that when you’re all on the honey moon (figuratively) and able to discuss calmly. Then, if your life or your personal relationship crash, you’re all able to fall back on the neutral business deal made with clear heads.
It doesn’t have to be complex too. Do they have a family office? They’ll be able to help. Just remember that you have the right to review the contract with your own lawyer if it end up heavy and complex…
I was lucky enough to have a similar situation to this. Don’t worry about the gift issue now, unless they have already given you $13million per parent before this. There is some consideration for if they charge interest below whatever the IRS “floor” is, but other people covered that already.
My advice is to make sure to have drafted official paperwork with a lawyer, and to turn on standard auto payments on to your parents. For example if you wanted to go to a bank in the future for a HELOC, second mortgage etc they like to see standardized payments and terms. Years later we applied for a HELOC and the bank flagged one month where my parents had “gifted” us a month off of the payment for Christmas.
Also, work with your parents to figure out how this factors into their estate. It’s morbid but, what happens when they die?
Private mortgages are pretty common. There are rules about the minimum interest rate, etc, but you should have no issues. I think the title company may even be able to handle it for you.
My parents did that with us. We got a house with 3% interest, and just made payments to them. We went to a title agency to get all of the appropriate paperwork.
Why dont the parents just form a trust, put the kids in the trust and then buy the house in the trust. Kids could contribute their intended down payment to the trust. I’m sort of guessing here but that seems doable.
It’s a very good way to ruin a relationship. Not saying it will but if there’s even a remote chance you can miss payments or run into issues I’d be very hesitant to go through with this. Sounds like you’re being cautious but this is a very personal thing for them to offer. I personally would never consider this with my parents or in laws, but if it works for you fair enough.
The downside is the risk your parents are taking in lieu of the bank.
There’s a service that would set this up for you, so you would legit be the owner, and your parents would legit be the mortgage ‘co’. Pretty sure it was National Family Mortgage that I used before. Was really cool.