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I have a private mortgage for my house in the US. (Not seller-financed. My parents are the lender.) The lender gifts me the interest amount each month and only the interest is paid on the loan. So, the principal is not changing and I effectively pay $0 per month.

If I sell my house and buy a more expensive house, could I obtain a traditional mortgage for the difference in cost of the new house?

Assumptions:

  1. Private mortgage loan amount is $400k
  2. I would receive $400k for the sale of the current house
  3. Terms of the private mortgage would stay the same for the new house
  4. Private mortgage terms would ensure no monthly payments over the life of the traditional mortgage
  5. Cost of new house is $600k
  6. I could qualify for a $200k mortgage (with 20% down if needed)
  7. Traditional lender will have primary lien

Thinking from the traditional lender's point of view this seems low risk. My debt to income ratio will be very low since I make no monthly payments on the private mortgage. Assuming the traditional lender can have the primary lien and they can verify by the private mortgage contract that no monthly payments will continue, I think they should view the $400k as essentially a down payment, but this is an unusual situation so I may be missing some things.

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  • how much equity do you have in the current house? – Fattie Aug 17 '20 at 15:08
  • $40k through appreciation but also have nearly $100k cash. I simplified a lot of assumptions to make the question manageable. Basically the private lender is eager to "cover" housing costs up to $400k without gifting that amount. – Fortunate Home Buyer Aug 17 '20 at 15:36
  • What was the purpose of the original arrangement? It seems like the only difference compared to them staying on the title and you living there is you get a house in your name instead of your parents being on the title, and you are responsible for the gain or loss in value when you sell it. The way you have it now though they have to pay income tax on the virtual interest payment (and you might also get to take the interest deduction). – TTT Aug 17 '20 at 15:45
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    The intent was that I would be responsible for the gain or loss upon selling it. (i.e. allow me to capture the appreciation on a large asset) Yes, they are paying tax on that interest, but it is set to the lowest amount allowed by the IRS. – Fortunate Home Buyer Aug 17 '20 at 16:00
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    I'm not quite clear on what you mean by "private mortgage" here. Seems like a lender would see the existing situation as a gift from your parents, not as a real mortgage - and thus wouldn't lend unless your parents were on the loan/title. – jamesqf Aug 17 '20 at 17:17
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Unfortunately (in the US) I think the answer is (unfortunately), in this day and age, "not a chance in hell". :/

They literally wouldn't even be able to enter your case in the system.

In the "old days" and in movies, a Wise Old banker at your local branch would Consider, Adjust Their Spectacles and Make A Decision. Unfortunately this is utterly gone with the wind since the r/e crisis and the government take over, effectively, of all mortgages. No banks carry anything, the mortgages are just passed along.

Approval for mortgages is utterly computerized (not by the bank, but by the system they are passing it up to) with no "decision making" whatsoever.

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  • Yes, I think you're right. What would be a better way to structure things to fit with the system assuming the private lender is very flexible on terms (potentially even an unsecured loan) but just doesn't want to outright gift the $400k? – Fortunate Home Buyer Aug 17 '20 at 15:41
  • You know I think that would be a separate question, @FortunateHomeBuyer - there are people on here expert in that! Surely, they would simply guarantee the mortgage, that would be the way to go? I'm not certain. – Fattie Aug 17 '20 at 16:24
  • I have to disagree with the absoluteness of the answer. While the large "big box" banks often just use the machinery, there are plenty of smaller lenders that are willing to take the time to do non-traditional mortgages. It's naive to say that the only way to get a mortgage is to structure it in one very specific way. – D Stanley Aug 17 '20 at 18:16
  • D, I bow to your experience, but, in recent experience (the last couple years) myself and colleagues have really found the "small, non-traditional" lenders ... are just now non-existent. Perhaps it's regional or something, but, (my experience) they're gone with the wind .. :/ – Fattie Aug 17 '20 at 18:31
  • I know of a good mortgage broker and if I do end up investigating this more I will certainly post an edit with the broker's thoughts! The reason I may buy a different house is for a location change, not simply to upgrade. I should really just count my blessings and move to a similarly priced house, but it is interesting to consider the options when rates are low. Thanks everyone – Fortunate Home Buyer Aug 17 '20 at 19:36
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I could qualify for a $200k mortgage (with 20% down if needed)

Presumably, that's 20% of $200k, which is only 6.7% of the total value of the house. So in all you're borrowing $560k on a $600k house. That may affect how they consider your application.

The bank won't see the $400k as part of the down-payment. It's borrowed money that you owe to somebody else.

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  • Good point. Hypothetically, let's say the $400k is an unsecured loan instead (I understand that's a bad idea). Then would the bank see the LTV as being 27% ($160k/$600k) – Fortunate Home Buyer Aug 17 '20 at 15:28
  • @FortunateHomeBuyer even if it were an unsecured loan, I suspect that the bank would be a bit nervous about lending $200k to someone who has an outstanding loan of $400k. – Simon B Aug 17 '20 at 16:16
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There's not a way to just "transfer" a mortgage from one property to another. The current mortgage will need to be released when you sell the house and a new mortgage established. Otherwise it's just an unsecured personal loan.

Most likely you'll need to refinance with the private lender as a second mortgage. The bank will want to be the primary lender to ensure that they get their money back in case of foreclosure.

So it's up to the bank as to whether they'll want to take the first mortgage, and up to the private lender as to whether they'd want to take the second. I would note that this is significantly more risk for the private lender since they're second in line (and not getting any principal back in the meantime). So I wouldn't be surprised if they weren't interested in refinancing the interest-only loan.

A simpler solution may be to just refinance as a single mortgage and have your parents continue to gift you some amount (perhaps the new interest amount?) if they want to. Any principal you may goes back to you as equity in the house.

My debt to income ratio will be very low since I make no monthly payments on the private mortgage.

Yes but it's somewhat artificial, and the bank may see through the unusual situation.

As a side note, if you can't afford to pay principal on the current mortgage, how are you going to afford to pay any principal and interest on the new mortgage? It sounds like you're getting yourself in a very dangerous situation.

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    I did not use the word "transfer". Mortgage would be released and a new one established. I said the bank would have the primary lien. I did not say I can't afford to pay principal on the current mortgage. You seem to have ignored my assumptions and made some of your own. – Fortunate Home Buyer Aug 17 '20 at 15:22
  • the question is a little confused, I also made those assumptions! anyway the point now is, we need someone to answer, as OP asks, "What would be a better way to structure things to fit with the system assuming the private lender is very flexible on terms (potentially even an unsecured loan) but just doesn't want to outright gift the $400k?" - a good question (perhaps a new question) – Fattie Aug 17 '20 at 16:25
  • apologies @DStanley I could have been clearer in the question. I may pose a new question – Fortunate Home Buyer Aug 17 '20 at 16:31
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    @FortunateHomeBuyer No apology needed - I did make some assumptions that may have been wrong. In any case it's an unusual scenario that may make it hard (but not impossible) for you to use find a lender willing to be a part of the arrangement. – D Stanley Aug 17 '20 at 18:25
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I agree with your assumption and I think you should have no problem getting a bank to approve a mortgage in this situation. From the bank's point of view, you are only taking out a loan for $200K on a $600K house, and the bank still gets the lien on the entire house, so there is nearly no risk for them.

When determining your ability to pay the mortgage, your income is balanced against all of your current debts and monthly payments towards those debts. The fact that you have an agreement with your parents that you owe them $400K isn't relevant to the application if you won't ever have a monthly payment towards that loan, unless your parents actually take a lien against your property, in which case the mortgage likely would not be approved (though, as long as the bank gets the first lien it still might).

Note that your situation isn't much different than if you didn't have the current property and your parents just gave you $400K as a gift to put down on the new $600K property. The key point about gifts for down payments is that banks want to make sure it's truly a gift and not a loan that would require adjusting the DTI (debt to income) calculation, so they may require signatures from the gift giver to prove it's truly a gift. But in your case, even though it's technically a loan instead of a gift, DTI would never be affected. Furthermore, the bank cannot lose a dime unless you default on the new mortgage and the value of the $600K home drops below $200K, which is extremely unlikely from an underwriting scenario. I believe this is a shoo-in. The complexity of your specific scenario is mostly just noise that shouldn't matter for securing a loan.

As a side note, you already have a 67% down payment. You won't need an additional 20% (of any number) to secure the loan or to avoid PMI. The 20% rule is only relevant in regards to the purchase price, not the loan amount. In other words, since your down payment is (much) more than $120K, there won't be any PMI.

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