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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.
Purchasing your first home is an exciting milestone But saving up for a down payment can be challenging, especially for first-time buyers If you’re struggling to come up with the lump sum, a loan from your parents may help cover the costs.
Getting a family loan has some advantages over traditional lending But mixing finances with family also requires care to protect relationships,
Below we’ll explore how loans from parents work for buying a house. We’ll cover the pros and cons, documentation required, and tips to keep your home purchase smooth when borrowing from family.
How Parent Loans Can Help You Buy a House
Here are some of the ways a loan from parents can assist with a home purchase
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Cover the down payment – Parent loans let you borrow the lump sum for a mortgage down payment rather than save for years. This gets you into homeownership sooner.
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Supplement your savings – If you have some savings but not enough, a loan from parents can provide the rest to reach your down payment goal.
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Bridge a mortgage gap – If you don’t qualify for a mortgage for the full amount you need, a family loan can fill the gap so you can still buy the home.
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Act as seller financing – Your parents can carry back a mortgage for you if you can’t qualify with a traditional lender.
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Gift equity – Rather than gifting cash, your parents can gift a portion of the home’s equity to help with your down payment.
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Lower costs – Avoiding lender fees can make buying a home more affordable.
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Flexible terms – Your parents may offer more flexible repayment terms than a bank.
Documentation Needed for Family Loans
While casual verbal agreements are common between family members, a house purchase requires formal documentation. Here are key documents to have when using a loan from parents:
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Loan agreement – Outlines loan amount, interest, repayment schedule, etc. This is important to prevent future conflicts over misunderstandings.
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Promissory note – Legal document that contains the loan terms and borrower’s pledge to repay. It can be used if the borrower defaults.
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Collateral agreement – If the home is used as collateral, this gives the parents a claim to it if the loan isn’t repaid.
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Gift letter – Required by lenders to document any gift funds used. Ensures it’s not a hidden loan.
Proper documentation protects both parties. It also shows underwriters the loan is genuine if you apply for a mortgage. Set clear expectations upfront to avoid problems later.
Pros and Cons of Family Loans for Home Buying
A loan from parents has advantages but also some drawbacks to weigh:
Pros
- More affordable than financing required down payment on your own
- Bypass lender qualifying and fees
- Flexible repayment terms
- Lower interest rate than consumer loans typically offer
- Tax-free gifts up to $16,000 annually from each parent
Cons
- Mixing family and finances can strain relationships
- May still need to qualify for remainder of mortgage
- Lack of formal loan experience by family members
- Parents have limited recourse if you default
- Gifts over $16,000 annually could be taxable
Assess your specific situation to see if the benefits outweigh the potential risks. Don’t enter into a family loan lightly.
Tips for Success When Borrowing from Parents
If you decide to go forward with a parent loan for a home purchase, keep these tips in mind:
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Get prequalified – Confirm you can qualify for the remaining mortgage amount needed before finalizing the family loan.
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Consult professionals – Talk to real estate and tax experts to avoid costly mistakes.
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Research rules – Know lender requirements for down payment loans and gifts from family.
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Document thoroughly – Have a clear written loan agreement and promissory note.
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Explain to lender – Disclose upfront you’re borrowing from family and provide documentation.
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Live below your means – Don’t overextend your budget so you can easily repay the loan.
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Communicate often – Set expectations early and keep your parents updated on your finances so problems don’t arise.
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Pay on time – Make regular on-time payments so you don’t ruin your credit or relationship with family.
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Have a backup plan – Be prepared in case you can’t qualify for the remaining mortgage needed.
Thoughtful planning reduces risks when mixing family loans and home buying.
Alternatives If a Parent Loan Doesn’t Work
While borrowing from family has its perks, it isn’t right for everyone. If your parents can’t or prefer not to provide a loan, here are some alternatives to look into:
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Mortgages requiring low down payments – Options like FHA or VA loans need as little as 3.5% down.
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Down payment assistance programs – State and local groups provide grants or low-cost loans to help buyers.
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Retirement account withdrawals – You may qualify to withdraw IRA or 401(k) funds for a first home purchase. Consider carefully, as you lose future tax-deferred growth.
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Low down payment mortgage options – Some conventional loans allow down payments as low as 3% but require mortgage insurance.
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Student loan repayment deals – A few lenders give breaks on rates for setting up automatic monthly student loan payments.
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Physician loans – Specialized mortgages for medical residents have flexible qualifying requirements.
Explore all your options to find the right financing mix if you can’t get a family loan for the down payment.
The Bottom Line
A loan from parents can be a huge help when buying your first home. It provides an affordable way to fund a mortgage down payment without derailing your savings. But make sure you take steps to protect relationships and avoid any costly missteps. Seek professional guidance, document the loan properly, and maintain open communication with family. Take a thoughtful approach so you smoothly transition to homeownership without causing division.
Frequency of Entities:
loan from parents: 15
parent loan: 8
family loan: 7
loan from family: 2
down payment: 16
mortgage: 11
home purchase: 5
house: 14
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.
Cons
- Potential for conflict: If the loan isnt repaid or the terms of the agreement are broken, it can strain a relationship. The family member or friend loaning the money must consider the chances of not getting it back and whether the loan will impact their own financial goals.
- Tax implications: If the family loan is interest-free and over a certain amount ($17,000 in 2023 or $18,000 in 2024), the lender may need to file a gift tax return. If the loan includes interest, the lender must follow IRS interest rate guidelines and potentially report it as income.
- No credit building: Payments toward a family loan arent reported to the three major credit bureaus, eliminating the opportunity to improve the borrower’s credit. Good credit scores can help you qualify for credit in the future, like a mortgage or car loan.
A lending circle can be a credit-building alternative to family loans. Lending circles are groups of trusted friends, family members or neighbors who take turns raising money for one member’s expense.
Is Buying A House From My Parents A Good Idea?
FAQ
Can I get money from parents to buy a house?
Can a parent loan a child money to buy a house?
How much money can I borrow from my parents?
Can my parents give me an interest-free loan?
Should you buy a house from your parents?
Buying a house from your parents is similar to a traditional home sale, but mixing family and finances comes with a few extra hurdles to navigate. These seven steps can help keep bad feelings at bay and ensure that you and everyone else in your family are treated fairly.
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 can parents help a child buy a home?
Some of the ways parents can help a child buy a home include a loan, a gift or co-signing a mortgage. Gifting a home, or the money to buy one, to a family member may incur a federal gift tax. Becoming a homeowner in today’s real estate market is a challenging goal, particularly for young, first-time buyers.
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.