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Question

Are there any downsides, or side-effects to paying off the remaining balance of a home mortgage with the help of an unsecured loan owed to a relative? Are there legal considerations that need to be addressed? Tax implications? Risks?

I have done some searching, but most of what I have found is that it is considered a bad idea to refinance a mortgage to pay off unsecured debt. I'm trying to do the opposite. I did find this link Significant personal loan to pay off mortgage but in that question, the personal loan seems to be from a bank with a possibly higher interest rate and seeks ways to get out of what seems to be a difficult situation.

Background

I currently have a 15 year fixed rate (3.0%) mortgage on a house in the US. The starting balance was $270k. We have been paying extra on it, and it currently has a remaining balance of $60k. We have no other debts.

I have $40k in cash. My relative has $20k in cash, and has offered it as a personal loan at 0% interest. Combined, these are sufficient to pay off the mortgage completely. From the point of view of the mortgage processor, I would own the property.

The relative and I are discussing writing a gentleman's contract for the terms of repayment (speed, amounts, frequency, etc..), and what happens in various what-if scenarios. The relative has stated that they do not want any collateral.

The spouse and I are both working, and are currently on track to pay off the mortgage in less than a year without this help. Taking this offer would accelerate that plan considerably.

From my point of view, this seems like a really good deal for me, and a generous blessing from the relative. What am I missing?

Update1

Thank you all for the items to consider. The Tale of Woe is an apt component that I had been contemplating, and is a big negative for this deal. This link Would it make sense to take a loan from a relative to pay off student loans? is similar in that the source of some of the payoff is a unsecured loan from family. These questions are similar in that regard.

With that said, my question is more around the implications of converting a secured loan into an unsecured one - shifting the risk. The comment about the IRS minimum interest rate (before which a loan is considered a gift) is definitely a new one on me. While it isn't a deal breaker, it does mean a slightly more complex tax return for me and the relative.

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    Taking this offer would accelerate that plan considerably. Would it? You're talking about a difference of $600 (20k * 3%) tops, since you are currently on track to pay off the mortgage in less than a year without this help...
    – CactusCake
    Jul 14, 2017 at 18:03
  • The question you should be asking yourself is if you have 40k why isn't your remaining loan amount not 20k instead of 60k
    – Victor
    Jul 15, 2017 at 1:55

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Are there legal considerations that need to be addressed?

Meaning are you breaking the law? No, but one thing you might consider is filing a new mortgage so that the relative has some recourse (via a lien on the house) should something go south, and for the tax reason described below.

Tax implications?

Here's where things get tricky. The IRS publishes a minimum rate of interest that you must charge to avoid the rest being classified as a gift. So depending on the amount and term of the loan, it could have tax consequences on both sides. Plus you might have trouble classifying the interest as mortgage interest (and thus be deductible) if there is not a mortgage in place.

Risks?

Boy are there. There are more than a few questions on this site regarding loans from relatives, all of which describe risks in detail.

I would agree with the comments and Pete's answer that it's not worth the minor savings in interest ($50 a month for $20k at 3%). Stay the course and don't do something this close to the finish line that you'll regret later.

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You can search other answers on the sites that are "tales of woe" which started with well meaning intentions of relatives loaning money.

The spouse and I are both working, and are currently on track to pay off the mortgage in less than a year without this help. Taking this offer would accelerate that plan considerably.

Two sentences in one paragraph and they contradict each other. In relationship to the length of the mortgage less than 1/3 of a year (20K/60K), or 4 months, is nothing. The interest saved is negligible as well.

While I applaud your desire to be mortgage debt free, this is a bad idea.

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