With a private mortgage, you don’t borrow from a bank. Instead, you borrow from another person or business. Whether it’s your only option, or one of many, it’s worth learning how these loans work and knowing what can go wrong.
As you evaluate where and how to borrow (or lend, if you’re the person with cash), keep the big picture in mind: typically the goal is to create a win-win solution where everybody gains financially without taking too much risk.
Why Go Private?
The world is full of lenders. So why not just call a 1-800 number and borrow money from the bank?
As a first-time homebuyer you might not be able to qualify for a loan from a traditional lender. Banks require a lot of documentation, and sometimes you won’t look the way they want you to look – even if you’re more than able to repay the loan. Self-employed individuals don’t always have a steady work history, and young adults might not have good credit scores (yet).
A loan among family members can also make good financial sense. Instead of paying interest to a bank, borrowers can pay interest to family members with excess money to lend. What’s more, the borrower will probably pay less interest (at a lower rate) and fewer fees to family than they’d pay to a traditional lender – but you’ll want to make sure to follow the rules if you plan on using a low rate.
Understand the Risks
Life is full of surprises, and any loan can go bad. Of course everybody has good intentions, and these deals often seem like a great idea when they first come to mind. But pause long enough to consider the following questions before you get too deep into something that will be difficult to unwind:
- How will the personal relationship between borrower and lender change?
- Will the lender’s financial security (ability to retire, risk of bankruptcy, etc.) be affected – especially if “something happens”?
- Who else may suffer if the loan is not repaid?
- Can you follow CRA’s rules related to gifting?
A lender, private or traditional, is always taking a risk. Ignoring relationship issues, the deal can go bad if you fail to consider:
- Is the property in good condition and a good location (can you get your money back if you sell it)?
- Will the property be adequately insured and cared for?
- Is there any other liens, mortgages, or interests conflicting with the private mortgage lender’s interest? In other words, who gets paid first?
Tax laws are tricky, and passing money around in large quantities can create problems. Before you do anything, talk with a local tax advisor who can help you minimize your risk.
Five Private Mortgage Tips
It’s tough to find certificates of deposit that pay 2% a year. But if you’re a bank lending to 30-year fixed-rate mortgage borrowers, you can earn 4%. Wouldn’t it be great to be a bank? Unfortunately, most people aren’t banks, so we’ve come up with these 5 tips to help you when doing a private mortgage.
Although opinions can vary when it comes to private mortgages, opinions are most favorable to the idea. Are you among those who are intrigued? Here are five tips:
Tip #1 – You have to charge interest: To avoid tax headaches, you need to collect at least a minimum amount of interest.
Tip #2 – You’ll need a promissory note: This spells out the terms of the mortgage, including the interest rate and the repayment period.
Tip #3 – You’ll need a deed of trust: Also known as a mortgage or security deed, this establishes that the loan is secured by the property and the lender has the right to take the property back, should the borrower fail to pay. For your son or daughter to deduct the loan’s interest payments, the deed of trust needs to be recorded with the appropriate local authority.
All this might sound complicated, but Halton Team Mortgage agents can help with all the necessary paperwork.
Tip #4 – Get title insurance: Your child should talk to his or her attorney about getting title insurance, but you might save money by not bothering with a separate lender’s policy.
Tip #5 – Think through the risks involved: As a rule, if your child couldn’t qualify for a mortgage from a bank, you probably shouldn’t be lending, either. Sure, there may be circumstances that you know about that perhaps a bank would be reluctant to consider. For instance, maybe your daughter is about to graduate and start a well-paying job.
You also shouldn’t write a private mortgage if you can’t afford to lose the money involved. To learn more about private mortgage contact an experienced professional.
How to Do a Private Mortgage Correctly
You have to think about unpleasant possibilities when considering a private mortgage. Imagine what could go wrong and how it would affect you.
For documentation, work with qualified experts. Talk to local attorneys, your tax preparer, and others who can help guide you through the process. If you’re talking about large sums of money, this isn’t a DIY project. Several online services handle everything for you – ask exactly which services are provided to be sure:
- Will you get written mortgage agreements?
- Can payments be handled and automated?
- Will documents be filed with local governments (to secure the loan, for example)?
- Will payments be reported to credit bureaus (which helps borrowers build credit)?
Think through everything before you move forward with a private mortgage.