A private mortgage is a home loan financed through a private source of funds, such as friends, family, or a business, rather than through a traditional mortgage lender. It can come in handy for people who struggle to get a mortgage the typical way.
This kind of mortgage can benefit everyone involved if it's executed correctly. However, without precautions, things can also go badly—for your relationship as well as your finances.
As you evaluate the decision to borrow or lend through a private mortgage, keep the big picture in mind. Create a win-win solution where everybody gains financially without taking on too much risk.
Key Takeaways
- A private mortgage bypasses an institutional lender. It involves borrowing the funds from a family member, friend, or business.
- If you have iffy credit, qualifying for this alternative homebuying process can be much easier, and loan terms are often more favorable.
- Private mortgages can, and should, form a lien against the property, just as a traditional mortgage would, so foreclosure is still possible.
- Have a professional such as an attorney draw up the paperwork if you decide to use a private mortgage. Don’t rely solely on a handshake.
Benefits of Using a Private Mortgage
The world is full of lenders, including big banks, local credit unions, and online lenders, so why not just fill out an application and borrow from one of them?
Ease of Qualifying
For starters, some borrowers might not be able to qualify for a loan from a traditional lender. Banks require a lot of documentation, and sometimes, a borrower's finances won't appear to be sound enough for the bank's preference. Even if you're more than able to repay the loan, mainstream lenders are required to verify that you can repay, and they have specific criteria to complete that verification. For example, self-employed people don't always have the W-2 forms and steady work history that lenders require, and young adults might not have good credit scores, because their credit histories are short.
Note
You can see for yourself how much a traditional mortgage might cost you with our detailed mortgage calculator.
Financial Advantages
A loan between family members can also make good financial sense.
Borrowers can save money by paying a lower interest rate to family members than they'd be able to get through traditional means. Just be sure to follow IRS rules if you plan to keep rates low; if your loan doesn't meet the Applicable Federal Rate (AFR), there could be tax implications.
Similarly, people with extra cash on hand can earn more by lending privately than they’d get from bank deposits such as CDs and savings accounts.
Understanding the Risks
Life is full of surprises, and any loan can go bad. You may agree to a personal mortgage with good intentions, but there are risks to consider beforehand.
Relationships May Change
Introducing debt into a relationship can be tricky. If money gets tight for the borrower, they may feel extra stress and guilt if they are unable to make payments. The lender, on the other hand, is put into the predicament of either sternly enforcing a payment schedule or taking a loss.
Circ*mstances May Change
Just as the borrower's financial situation may change, so can the lender's. Evaluate the lender’s ability to take on the risk of a large loan before moving forward. This is especially important if others are dependent on the lender, such as children or a spouse. Consider whether making the loan may affect the lender's ability to retire, care for dependents, or make other important financial moves.
Property Value May Fluctuate
Real estate is expensive, and the value of a property can vary greatly over time. Lenders need to be comfortable with the condition and location of the property, and confident that its value will not decrease.
Maintenance Can Be Expensive
It takes time, money, and attention to maintain a property. Even with a satisfactory home inspection, issues can come up. Lenders need to be sure the resident or owner will be able to pay for maintenance and address any problems before issues get out of hand.
The Title May Not Be Clear
The lender should insist on securing the loan with a lien. If the borrower adds any additional mortgages, or if somebody puts a lien on the house, this ensures the lender will get paid first. However, you’ll also want to check for any issues before the sale. Traditional mortgage lenders insist on a title search, and the borrower or lender should ensure the property has a clear title. Consider title insurance, which provides extra protection.
Your Taxes May Be Affected
Tax laws are tricky, and moving large sums of money around can create problems. Before you do anything, speak with a local tax adviser so you’re not caught by surprise.
How To Structure Your Private Mortgage
Any loan should be well documented. A good loan agreement puts everything in writing so that everyone's expectations are clear, and there are fewer possible surprises. Years down the road, you or the other party may forget what you discussed, but a written document will spell out the details.
Documentation does more than just keep your relationship intact—it protects both parties of a private mortgage. As you review your agreement, make sure every conceivable detail is spelled out, starting with:
- When are payments due (monthly, quarterly, on the first of the month), and is there a grace period?
- How and where should payments be made? Are electronic payments preferred?
- Can the borrower prepay, and is there any penalty for doing so?
- Is the loan secured with any collateral?
- What can the lender do if the borrower misses payments? Can the lender charge fees, report to credit reporting agencies, or foreclose on the home?
It’s wise for the lender to secure their interest—even if the lender and borrower are close friends or family members. A secured loan allows the lender to take back the property through foreclosure and get their money back in a worst-case scenario.
If the property is held in the borrower’s name only—without a properly filed lien—creditors can go after the home or pressure the borrower touse the home’s valueto satisfy a debt.
Enlist Professional Help
For documentation, work with qualified experts. Talk to local attorneys, your tax preparer, and others who can help guide you through the process. You're working with large sums of money; this isn't a DIY project. When hiring a professional, you may want determine the following:
- Will you get written mortgage agreements?
- Can payments be handled by somebody else (and automated)?
- Will documents be filed with local governments (to secure the loan, for example)?
- Will payments be reported to credit bureaus (which helps borrowersbuild credit)?
Professional help at the outset will ensure your private mortgage arrangement continues to benefit both parties for the life of the loan.
Frequently Asked Questions (FAQs)
How do you find private mortgage lenders?
Aside from asking friends and family, you may find private mortgage lenders by networking with real estate professionals and investors in your area. There may be investors who are interested in a somewhat unconventional opportunity.
When do lenders require private mortgage insurance?
Private mortgage insurance is typically required when the buyer has less than 20% equity in the home. It's ultimately up to the lender as to whether they want to impose insurance requirements.
Who regulates private mortgage lenders?
There isn't a specific government agency that oversees private entities that act as lenders. If you have a legal issue, you will need to consult an attorney to discuss your situation and options.
As an expert in the field of real estate financing and private mortgages, I've delved into the intricacies of this alternative homebuying process. With a wealth of knowledge and hands-on experience, I can provide insights into the key concepts discussed in the provided article.
Private Mortgage Overview: A private mortgage is a home loan funded through non-traditional sources, such as friends, family, or businesses, bypassing institutional lenders. This can be a viable option for individuals facing challenges in securing a mortgage through conventional means.
Qualifying for a Private Mortgage: The article rightly points out that individuals with iffy credit or unconventional financial situations may find it easier to qualify for a private mortgage. Traditional lenders often demand extensive documentation, making it difficult for some borrowers, such as self-employed individuals or those with short credit histories.
Financial Advantages of Private Mortgages: Private mortgages offer financial advantages for both borrowers and lenders. Borrowers may secure lower interest rates from family members than from traditional lenders. Simultaneously, lenders can earn higher returns by privately lending their funds compared to traditional investment options like CDs and savings accounts.
Understanding the Risks: The article highlights the potential risks associated with private mortgages, emphasizing the impact on relationships and the need for careful consideration. It touches on the fact that life's uncertainties can lead to changes in both the borrower's and lender's financial situations.
Structuring a Private Mortgage: Proper documentation is crucial for any private mortgage agreement. The article stresses the importance of a well-drafted loan agreement to ensure clarity of expectations and protect both parties involved. Key details to include in the agreement are payment terms, collateral, prepayment options, and actions in case of missed payments.
Enlisting Professional Help: To navigate the complexities of private mortgages, the article recommends seeking professional assistance. This includes working with attorneys, tax preparers, and other experts to ensure proper documentation, compliance with legal requirements, and protection of both parties' interests.
Frequently Asked Questions (FAQs): The FAQs section addresses common queries about private mortgages, such as how to find private mortgage lenders (networking with real estate professionals), when lenders require private mortgage insurance (typically with less than 20% equity), and who regulates private mortgage lenders (no specific government agency, requiring legal consultation for issues).
In conclusion, a private mortgage can be a beneficial alternative, but it requires careful consideration, proper structuring, and professional guidance to mitigate potential risks and ensure a mutually beneficial arrangement for both borrowers and lenders.
