I’m considering becoming my incredibly reliable son’s mortgage lender. He has a hefty downpayment of his own, but given the current interest rate, the type of house he’s looking for is still out of reach. However, if (like a bank) I loan him the amount (minus his downpayment) that he needs in cash with an interest rate set by the IRS (currently the AFR is around 3.8%) or slightly over, his payments would be more than doable. I’m thinking the interest rate would be 4%, which is about what I’m getting on a pile of CDs right now. Doing so would certainly impact the liquidity of my investments, but I think I’d still be okay. Obviously, we’d go to a lawyer and create all the necessary paperwork. I’m wondering if anyone in this smart community has done this, and if so, if you might have advice.
We did this during Covid to help DS/DIL buy their first house. You are absolutely right to use your attorney to make sure it’s structured correctly. You don’t want there to be any question for IRS purposes that this is not a gift. We were advised to use a rate that was slightly above the AFR. And to further help the kids out, we structured it as an interest only loan so they could invest what would have gone toward the principal. It also made the bookkeeping very simple because we avoided amortization schedules. And be sure to report the interest on your tax return. Rates were really low at that time we did this so the interest wasn’t enough for the kids to itemize. If you son will itemize you’ll need to provide him with an interest statement to use on his taxes.
Another benefit to this type of mortgage is when your son is making an offer on a home. Because he will not need outside financing, it will be treated as a cash offer and can put him in an advantageous position relative to other potentials buyers.
That’s really helpful. Thank you. Just scribbled down “interest only loan.”
In the past, DS/DIL made offers and lost out to cash buyers, so, yes, I’m hoping this might make a difference there.
LOL. We could’ve written this just about word for word. Almost did a double take reading this except we did it a year ago for son and wife to get into a house with fast close date at super price.
We drew up contract (real estate attorney) and like you took care to make sure it’s not considered a gift. Interest rate is 4% I believe which was in IRS guidelines. And same as you, we figured the return on investment was good as any we were getting elsewhere. We were easily able to afford it and frankly thought the home was a great investment on it’s own.
Minimum long term AFR–interest only loan
And now it’s been a year. Feels great to have been able to get kids into a nice neighborhood and get them started. But make no mistake–it’s not a gift. Just a way to provide a more affordable path for them.
such parent-as-mortgagor has been around for years. And, if you are so inclined, you can gift him $19k by forgiving that much debt. (19 per person, so if you are married, x2, or $38k, and if son is married, $19k * 4)
Great to have this reinforcing feedback. I’m a widow, and although I think I’m in pretty good shape financially, I do worry about giving too much at this time of my life. Although I have been gifting my kids smaller amounts every year, I want to make sure I won’t be a burden to the kids down the road. So a big gift would make me uneasy, but an investment this way is different. I’ll still be receiving the interest I would have received with CDs. The only thing I thing I think I’m risking is some liquidity, because most of my other investments are in mutual funds.
Thanks for all your replies!
We have considered eventually doing something similar for dd. If the money you’ll be using to fund the loan is in a taxable investment account, don’t forget to calculate how much tax you’ll pay on the withdrawals when figuring out what to charge your son for interest. Also, make sure you know how you will generate a annual 1098 for your son so he can deduct any interest he’s paying (if he itemizes).
Regarding the interest only loan idea: I loaned my niece the money for a down payment on her first house. Terms were 4% over 5 years. When she paid me back after 2.5 years, I offered to return the interest she paid me if she produced a receipt for an equal deposit made to her Roth IRA that year (her 401 was fully funded but she wasn’t contributing to an IRA at the time). Perhaps you could do something similar with the principle portion of the payment in order to help son avoid any temptation to skip the monthly investment contributions.
Awful thing to bring up to a parent- but have you considered PMI? Or perhaps your lawyer will suggest/insist on it?
Terrible to even think about it. But if the amount you are lending represents a significant part of your eventual retirement plan, you need to protect yourself.
Also- is there a spouse or potential spouse in the picture???
I’m talking to my accountant this week to get a clear picture of what I might pay in taxes if I liquidate a couple of things. All very helpful to keep in mind. Thanks!
PMI is not a bad thought. DS and DIL divorced very amiably a year ago. But having worried unnecessarily about the division of assets during that process, I will want to make sure that this loan is specific to him. More to think about as we draw up legal papers. Thanks!
Dont forget that banks escrow for taxes and often handle the insurance (at least the first policy at closing) and get notices if there could be a lapse.
Why would they need PMI? That is required for federally insured loans where they don’t put down at least 20%. That was a requirement after the bank failure of 2007-2008 because of all the low/no down payment loans that went upside down when home values plummeted and the lender failed and the govt bailed out the banks and sold the homes or loans at a loss. I doubt @Leaper12 has a bank in his/her basement and has to follow those regulations (often only after the bank makes 25 loans in a year). If the son defaults, @Leaper12 will suffer a loss but the federal govt or FDIC is not going to reimburse @Leaper12. Same with making Truth in Lending disclosures and RESPA disclosures, not required until a certain number of loans are made.
You mentioned children. Could you do this for all of your children, if they asked?
All good points.
There’s a bit of equalization going on here. With my son’s approval, I transferred some property I owned to my daughter some years back. At that time, my son had a house with his wife, and my daughter didn’t own anything. Now, it’s his turn. My kids all know everything, and we talk, so it’s all good.
FWIW, there is a company that sets up and administers such mortgages, and does it all “on the books” so that the borrower can build credit and deduct the interest paid (though of course this means that said interest is taxable income for the lender). I don’t think I’m allowed to name the company, but if you do a search on intra-family mortgages, it will be one of the first links that comes up.
We do this for my daughter & SIL. I don’t know the legal specifics as DH handled. We also gave/gifted them money to fix up the first home they bought. We plan to do something similar for my younger daughter when she is ready to purchase a home.
We loaned one s some money towards his down payment. What we did was the same (I believe) 4% loan but in addition to his paying a chunk back pretty quickly, we gift our kids $ every year so we did that to s and his w at the beginning of the year as a payment towards his loan. Doing it at the beginning of the year cuts the interest too.
I knew I came to the right place. I’m learning more and feeling more secure in this decision. Thanks, everyone!
In the agreement make sure he takes out homeowners insurance for the replacement of the house, that’s what a bank would require. You would have the first lien on the house in case he should take any future loans on the house. I think that would part of the title.
Only if they file the mortgage/deed of trust against the house. It sounds like this would be a personal, unsecured loan. They can make it a secured loan and file the mortgage, or they could put their name on the deed (that would be as a co-owner not as a creditor) but I don’t think that’s what anyone wants.
The title company can be very helpful in how to set it up (assuming the sellers are giving a warranty deed and buying a title policy at sale).