13

First time here, so please be gentle!

I am thinking of buying a home, and have enough steady income to comfortably afford the monthly payment on the loan. However, I will need help with the down payment. One of my family members has suggested this offer:

  • He pays the full down payment, which will be up to 30% of the home price. The exact percentage depends upon the price of the house I buy, but will be close to 30%.
  • It will be a loan, and I don't need to pay anything to him for 5-7 years.
  • After that period, assuming we sell the home, I give him the amount of the loan plus 50% of any profits / losses from the sale of the house.
  • If I don't sell the home, we will take the then current value of the house, and add 50% of the profit / loss to the loan amount, which I would then owe him (to be paid at an interest if I don't have that money at that time).

I am very close to the said family member and I trust him, but I wanted to ask the community if this makes sense financially / practically.

Please let me know if you need more details, or if this question is not appropriate here.

Thanks!

  • 5
    Make sure that the bank is aware of this arrangement and is OK with it. If you tell the bank this is a gift and get into trouble down the road, the bank will consider you in default automatically, and you may have some exposure from a civil/criminal liability perspective. – duffbeer703 Jun 9 '11 at 12:53
  • For a financial arrangement, there's a lot of bases not covered: How do you value the house without selling it? Is it 5 years, or 7? What constitutes profit / loss? What happens if prices tank before the valuation date, then recover by the time you sell the house and move on? – Josh May 9 '17 at 17:19
  • Banks ask for down payments to ensure the financial stability of the loan holder - what are the details of your finances? Knowing this could make or break whether or not you should be buying a home at all. Let alone taking this loan that is guaranteed to be several times that of the interest rate on the house itself. – Zibbobz Apr 23 at 16:28
14

Say you're buying a 400K house. Your relative finances 120K (30%).

Say I'm optimistic, but the real-estate market recovers, and your house is worth 600K in 5-6 years (can happen, with the inflation and all). The gain is 200K. Your relative gets 100K. You repay him 220K on 120K loan for 5 years. Roughly, 16% APR. Quite an expensive loan.

I'm of course optimistic, it seems to me that so is your relative.

The question is: if the house loses value in that term, does your relative take 50% of the losses?

Make calculations based on several expected returns (optimistic, "realistic", loss case, etc), and for each calculate how much in fact will that loan cost. It will help you to decide if you want it. Otherwise your relationships with your relative might go very bad in a few years.

BTW: Suggestion: it's a bad idea to mix business and friend/family you don't want to lose.

  • 4
    @user3885 - you will owe, you just won't make payments. I guess that that is what you meant. You can take a balloon loan and still have less interest to pay (if the prices are really going up, if the prices are going down though then the loan with your relative is a good deal). – littleadv Jun 9 '11 at 4:11
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    @gnasher729 But the buyer did make an investment. Who pays the cost of the financing of the other 70%? Who carries the risk of foreclosure? Private loan is most likely a recourse loan - unless the OP declares bankruptcy, the relative will get his money back. – littleadv Jul 2 '14 at 7:43
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    @gnasher729 no, buyer was not OK. Buyer was -400K in debt. – littleadv Jul 2 '14 at 20:40
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    @gnasher729 incorrect. Buyer goes from zero to 400K house and 400K debt. Relative goes from 120K cash asset to 120K loan asset. Private loans are recourse loans almost universally, in this scenario the relative is very unlikely to lose anything. Definitely not the whole 120K. – littleadv Jul 4 '14 at 0:39
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    +1 "it's a bad idea to mix business and friend/family you don't want to lose". You'll lose business and friend. – algiogia Apr 13 '15 at 9:56
7

I would recommend against loans from family members. But if you decide to go down that path take care of the basics:

  1. get an attorney to draw up a contract (split the attorney fees)
  2. agree to terms (including bail out terms)
  3. sign the contract

This is a business decision so treat it like one. I would add that the situation you describe sounds extremely generous to your family member. I'd look at standard loan agreements (ie. in the marketplace) and model your situation more on them - if you do this, even with you paying a premium, you'd never come up with something as generous as what you have described.

  • Yes, we will definitely make it as official as possible. We both realize that it's extremely generous to my family member, but are there any loan schemes that I don't pay anything on for the first 5 years? I would really love to know, because then I can look at those to see what's realistic. – user536048 Jun 9 '11 at 3:39
  • "are there any loan schemes that I don't pay anything on for the first 5 years" - That's exactly the sort of thing I'm talking about. You don't see such schemes out there. Please note I'm thinking about this both ways - for you and the family member loaning you money. The agreement should be realistic for you both. – gef05 Jun 9 '11 at 12:59
5

Keep in mind that lenders will consider the terms of any loans you have when determining your ability to pay back the mortgage. They'll want to see paperwork, or if you claim it is a gift they will require a letter to that effect from your relative.

Obviously, this could effect your ability to qualify for a loan.

  • Thanks. So theoretically, what happens if we made it an "informal" loan, so that the lenders don't see it either as a gift or as a loan, but as my money? My guess is that it's illegal, right? – user536048 Jun 9 '11 at 3:40
  • The legality depends on how it happens and what you sign, but probably, yes. – Sean W. Jun 9 '11 at 4:00
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    Also, they will see a large deposit in your bank statements and ask you about it. You will probably not be approved without a good explanation. – Sean W. Jun 9 '11 at 4:01
4

In effect, you are paying for 70% of the house but he gets half the gain. On the flip side, you're living there, so that probably makes up this difference. It will be toughest if the house jumps in value, to the point you might be forced to sell. You might want to think about that a bit.

  • Thanks. You mean I might be forced to sell by the family member if the price goes up a lot? That won't happen. Or did you mean something else? – user536048 Jun 8 '11 at 3:59
  • If you are very lucky, and the home doubles in 5 years, not impossible, the other guys 30% value doubles as well. If you can't pay that off, what will you do? – JTP - Apologise to Monica Jun 8 '11 at 4:04
  • Ah, I see. The amount I am unable to pay in this case will be a loan that I can pay off slowly. We have already agreed on a loan plan for such a condition and we are okay with that. (I seem to be unable to upvote until I get 15 points :( ). – user536048 Jun 8 '11 at 4:09
  • Not a problem. Littleadv did a great job with a numerical example. Each 10% increase is a 17% return to the relative. If housing recovers a decent amount, the lender really benefits. – JTP - Apologise to Monica Jun 8 '11 at 16:47
  • Yes, I am okay with that. If the housing recovers a decent amount, I make a decent return on my investment as well, which I wouldn't be able to without the loan to begin with. – user536048 Jun 9 '11 at 3:41
3

Lenders pay attention to where your down payment money comes from. If they see a large transfer of money into your bank account within about a year before your purchase, this WILL cause an issue for you.

Down payments are not just there to make the principal smaller; they are primarily used as an underwriting data-point to assess your quality as a borrower.

If you take the money as loan, it will count against your credit worthiness. If you take the money as a gift, it will raise some other red flags.

All of this is done for a reason: if you can't get a down payment, you are a higher credit risk (poor discipline, lack of consistent income), even if you can (currently) pay the monthly cost of a mortgage. (PS - The cost of home ownership is much higher than the monthly mortgage payment.)

Will all this mean you WON'T get a loan? Of course not. You can almost always get SOME loan. But it will likely be at a higher rate than you otherwise would qualify for if you just waited a little bit and saved money for a down payment.

(Another option: cheaper house.)

EDIT:

The below comments provide examples where gifts were/are NOT a problem.

My experience from buying a house just a few years ago (and my several friends who bought house in the same period, some with family gifts and some without) is that it IS an issue.

Your best bet is to TALK, IN PERSON with an actual mortgage broker in your area who can go through the options with you, and the downsides to various approaches.

  • 1
    They don't look a year into your bank account. Just 90 days is fine. As long as you justify the money as a gift with a letter from the family member, this will suffice. It's covered under HUD, Fannie/Sallie Mae rules. – Brian Jul 2 '14 at 12:05
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    When I bought my house (April 2013), I took a small amount of down payment (closing cost) assistance from my sister. They had us sign a paper that the money was a gift, not a loan, and there was no expectation of repayment. – Noah Jul 2 '14 at 14:09
  • @staticx - you are suggesting the OP lie to the bank? – JTP - Apologise to Monica Jul 2 '14 at 14:32
  • @JoeTaxpayer: No, how would the OP be lying? Let's say he gets the money and it sits in his bank account for two years. He never uses it. Then he goes to buy a house and has say $15k in savings. The bank isn't going to ask where that $15k came from. The gift letter would be a moot point. – Brian Jul 2 '14 at 14:48
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    I can't say how 120K loan from a family reduces the risk. The bank has no risk as long as the 400K house can be sold for 280K if he fails to pay. In case of default, the bank mortgage has priority and the relative gets nothing. – gnasher729 Jul 2 '14 at 15:33
0

I'll compare it to a situation that is different, but will involve the same cash flow.

Imagine the buyer agrees that you buy only 70% of the house right now, and the remaining 30% in 7 years time.

It would be obviously fair to pay 70% of today's value today, pay 30% of a reasonable rent for 7 years (because 30% of the house isn't owned by you), then pay 30% of the value that the house has in 7 years time. 30% of the value in 7 years is the same as 30% of the value today, plus 30% of whatever the house gained in value.

Instead you pay 70% of today's value, you pay no rent for the 30% that you don't own, then in 7 years time you pay 30% of today's value, plus 50% of whatever the house gained in value. So you are basically exchanging 30% of seven years rent, plus interest, for 20% of the gain in value over 7 years. Which might be zero. Or might be very little. Or a lot, in which case you are still better off.

Obviously you need to set up a bullet proof contract. A lawyer will also tell you what to put into the contract in case the house burns down and can't be rebuilt, or you add an extension to the home which increases the value.

And keep in mind that this is a good deal if the house doesn't increase in value, but if the house increases in value a lot, you benefit anyway. A paradoxical situation, where the worse the deal turns out to be after 7 years, the better the result for you. In addition, the relative carries the risk of non-payment, which the bank obviously is not willing to do.

protected by Community Mar 20 '16 at 2:07

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