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Borrowing from family may seem like a low-cost option if you need money for a down payment on a home, to start a business or repay high-interest debts. It can also be a convenient way to get quick cash if you lose your job or encounter an emergency expense.
Defaulting on a family loan could put your relationship with the lender at risk and add strain to your family member’s finances. Successfully loaning money to family requires clear communication and maybe even a written loan agreement. Family lenders must also consider IRS guidelines.
Here’s what to know about getting a personal loan from a family member, including the pros and cons, how to formalize a family loan and alternatives to consider.
Getting financial help from your parents to purchase your first home can be a huge blessing But borrowing money from family to buy a house also requires careful planning,
In this comprehensive guide, we’ll discuss everything you need to know about getting a loan from your parents for a down payment or entire home purchase.
Key Benefits of a Family Loan for a Home
There are several potential advantages to borrowing funds from your parents versus a bank:
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Lower interest rate – Your parents will likely charge you less interest than a traditional lender This saves money over the life of the loan
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Flexible terms – Your family can customize loan terms like the repayment period that best suit your needs
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Easier to qualify – Income and credit requirements may be looser compared to a bank.
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Less fees – Avoid lender fees for origination, underwriting, etc.
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Faster process – Skipping the formal lending process makes things simpler and quicker.
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Build credit – If structured properly, repaying the loan can help establish your credit history.
As long as expectations are clearly outlined upfront, borrowing from family can be mutually beneficial.
What Are the Downsides of a Family Loan?
However, accepting money from parents isn’t without potential disadvantages:
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Strained relations – A loan gone bad could damage your relationship.
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Tax complications – Improperly structured loans may have gift tax consequences.
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No consumer protections – Family loans lack the protections offered by banks.
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Less motivation to repay – You may be lax about repaying family like you would a bank.
To avoid issues down the road, treat the loan like a professional lender would. Put everything in writing upfront.
What Are Some Options for Family Financing?
There are a few different ways your parents could provide funds to help you buy a home:
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Loan – Formal loan with promissory note, interest, set repayment schedule, etc.
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Gift – Parents simply gift you cash with no expectation of repayment.
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Gift of equity – Parents sell you their home below market value as a gift.
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Co-sign loan – Parents act as guarantor on your mortgage loan.
Let’s dive into the pros and cons of each approach.
Family Loan for Down Payment
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Your parents lend you money for the down payment and closing costs. You take out the mortgage.
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Agree on interest rate, term length, payment amount, etc. Document with a promissory note.
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Interest paid to parents may be tax deductible if loan is for your primary residence.
Gift Funds
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Parents gift you cash with no expectation of repayment.
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Up to $16,000 per year ($32,000 for married couple) is tax-free. Anything above that is subject to gift tax.
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Must document gift with a letter stating the funds don’t need to be repaid.
Gift of Home Equity
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Parents sell you their home below market value as a gift.
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Difference between sales price and appraised value is considered a tax-free gift.
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Allows you to buy the home with a lower down payment.
Co-Signed Mortgage Loan
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Parents co-sign the mortgage loan, acting as guarantors. You make all payments.
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May help you qualify for better rates/terms or a larger loan amount.
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Risks parents being liable for the debt if you default.
Each approach has pros and cons to weigh based on your specific situation.
What Should the Family Loan Terms Include?
To keep sibling relations harmonious, it’s best to treat the family loan just like a bank loan. This includes:
- Formal promissory note detailing all terms
- Notarization
- Fixed interest rate
- Exact monthly payment amount
- Payment due date each month
- Balloon payment or installment structure
- Due on sale clause
Clarifying expectations upfront minimizes misunderstandings later. Consider working with an attorney to ensure the agreement is properly structured.
How Does the Family Loan Impact Your Home Purchase?
When receiving funds from family, there are a few key considerations regarding your mortgage:
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Down payment source – Lenders require a paper trail for your down payment. You’ll need a gift letter if funds will not be repaid. Or proof of the family loan if they’re lent.
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Loan-to-Value (LTV) – The sale price, appraisal, and your down payment determine the LTV ratio that decides your interest rate/terms.
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Income & Debt – When qualifying for the mortgage, lenders will factor in the additional debt obligation of the family loan payment.
To make sure the loan amount and terms work, get pre-approved by your lender early in the home buying process.
What Happens When It’s Time to Repay the Loan?
You’ll need a plan in place for repaying the family loan:
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Monthly payments – Make sure to make agreed upon monthly payments on time. Consider setting up auto-pay.
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Refinancing – You may be able to pay off the family loan by refinancing into a new mortgage with cash out.
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Home equity loan – Down the road, a home equity loan or line of credit can provide funds to pay off the family loan.
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Sale proceeds – When you eventually sell the home, use a portion of the sale proceeds to repay your parents.
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Early payoff – Accelerating payments to pay the loan off early can save on interest. Discuss options with your family.
The key is staying in frequent communication with your parents around the repayment plan.
What Happens if I Default on the Family Loan?
No one expects to run into issues repaying family, but defaults do happen. Here are some potential scenarios:
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Your parents could require you to immediately repay the loan in full. Make sure you know the acceleration clause.
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If secured by the home, your parents could foreclose on the property forcing a sale.
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The strain could permanently damage your relationship with your parents.
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Your parents may be able to claim a tax loss for the unpaid amount as a bad family loan debt.
Bottom line — make the loan payment a top priority each month. If issues arise, speak to your family right away to modify the terms.
Should Parents Charge Interest on the Loan?
Whether or not parents charge interest depends on their goals:
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To avoid any gift tax, the IRS requires charging at least the minimum applicable federal rate (AFR) for interest.
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Charging little or no interest provides more financial help upfront.
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Interest paid to your parents may be tax deductible if the loan is for a primary residence.
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Interest paid helps avoid a potential IRS audit of the family loan.
Discuss intentions upfront so there are no surprises or misunderstandings regarding interest and repayment.
Is a Co-Signed Mortgage Loan Better?
Rather than lending you funds directly, another option is having your parents co-sign your primary mortgage:
Pros
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May help you qualify for a better loan program or interest rate.
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Allows you to borrow a greater amount.
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Simpler structure without separate loan documents.
Cons
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Puts your parents on the hook for the mortgage debt if you stop paying.
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May still impact your debt-to-income ratio for qualification purposes.
A co-signer gives the lender more security, but also exposes your parents to financial risk. Weigh options carefully.
How Do I Make Sure I Don’t Ruin Family Ties?
Any exchange of money between family members is sensitive. Here are tips for keeping the home loan from ruining relationships:
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Discuss all options transparently and decide what works best for all parties. Don’t assume.
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Consult attorneys and accountants to ensure the loan is structured properly and legally.
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Put the full terms in writing in a promissory note and consider notarization.
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Treat the loan with the formality of a bank – strict payment schedule, interest due, etc.
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Maintain open and clear communication with your parents at all stages.
With thoughtfulness on both sides, a family home loan can greatly help you achieve the dream of homeownership while bringing your loved ones closer together.
Frequency of Entities:
Parents: 28
Family: 16
Loan: 23
Home: 22
You/Your: 48
Interest: 11
Down payment: 7
Mortgage: 6
House: 10
Gift: 4
Taxes: 3
Pros and cons of family loans
- Easy approval: Theres typically no formal application process, credit check or income verification when youre borrowing from family or friends. Traditional lenders often require documents such as W-2s, pay stubs and tax forms as part of the loan application.
- Low costs: Since the loan is coming from a loved one instead of a for-profit corporation, you may get a loan at a much lower interest rate than what a bank, credit union or online lender might offer. Family members are also unlikely to charge late fees or the upfront origination fee that lenders sometimes charge.
- Hardship options: Family members may be more lenient than other lenders if you encounter a hardship, like a job loss or illness, letting you pause or suspend payments for a period of time.
- Helps avoid risky loans: Family loans can help you avoid payday and other high-interest lenders that charge unaffordable rates.
What is a family loan?
A family loan is a loan between family members. You could create a similar loan arrangement between friends, significant others or roommates.
With this type of loan, it’s up to you and the lender to decide how it’s structured. A family loan can have interest or not and be repaid in installments or a lump sum. It can be unsecured, or you could provide collateral. The loan can be informal or formalized with a loan agreement.
Family loans can help you avoid expensive no-credit-check loans and don’t have many barriers to approval, but the potential downsides include tax implications and a bit of awkwardness.
How to Buy a House from a Family Member with No Money DOWN!
FAQ
Can I get a loan from my parents to buy a house?
How to get money from parents for a house?
What is the $100,000 loophole for family loans?
Can children get a home loan if their parents buy a house?
Consider these alternatives, too: Become a co-borrower or co-signer. Children can become co-borrowers on their parents’ purchase or refinance and specify that they will not live in the home. With co-signing, the children are helping their parents get loan approval with no expectation of living in the home.
How do I get a home loan if my parents have a mortgage?
The latter involves shopping and applying for a mortgage loan. You’ll need to qualify based on your income, credit, and other factors. Or, if your parents’ mortgage is assumable, you may be able to pay a flat fee and assume the existing mortgage and its debt. Most FHA, VA, and government loans are assumable.
Can I buy my parent’s home if I don’t have cash?
If you don’t have the cash to buy your parent’s home, you’ll need to apply for a home loan. Let your lender know upfront that you’re buying from a relative. A purchase between family members is considered a “non-arm’s length” transaction, which simply means the buyer and seller are related.
How do I buy a house with my parents?
You can pursue a variety of mortgage loans when buying a house with parents or an adult child. A few of the best options include: Fannie Mae HomeReady Loan — The HomeReady loan is ideal for lower-income borrowers. “These are for first-time home buyers whose credit score is at least 620 for fixed rates and 640 for adjustable rates.