Four years ago, 34-year-old, Chandra Webb left St. Louis, Missouri, for a job in Jackson, Mississippi teaching health and physical education to junior high school students. She rented a two bedroom apartment, and resided there for about three years.
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Her 74-year-old father, Hezekiah Webb, a retired State Farm agent who lives with his wife in O’Fallon, Illinois, was interested in helping his daughter create financial security. He knew that would be a challenge on Chandra’s teacher salary, which is $37,000 a year.
“I wanted her to have something more secure than an apartment. I wanted her to have a house with a garage,†says Hezekiah. “I also wanted to figure out how I could help her stabilize her finances,†he adds.
Hezekiah read an article on how some people were financing homes for their children through financial vehicles called intrafamily mortgages, and decided that he wanted to do this for his daughter.
Intrafamily mortgages work exactly like traditional mortgages. There is a borrower, in this case Chandra, and a third party institution that structures and manages the loan, as well as collects monthly payments. In addition, there is the lender, a family member, instead of a bank or financial institution like traditional mortgages.
“Eighty-five percent of our clients are parents trying to help their adult children,†says Timothy Burke, founder and CEO of National Family Mortgage, the leader in the space.
According to a national survey commissioned by Better Homes and Gardens Real Estate, more than two-thirds of all baby boomers said they want to provide future financial support for their children or grandchildren to purchase a home, like these mortgages allow them to do.
National Family Mortgage has done more than $330 million in loan volume. The largest individual loan has been for $2 million, and the smallest to date is $11,000. Burke says in addition to mortgages for home purchases, the company structures loans for down payments on homes, renovations, and refinancing existing mortgage balances.
Realizing Her Dream
Chandra has now lived in her dream house for about a year. The 1800-square-foot home cost $200,000 and has a two car garage and three bedrooms. She and her father decided the best way to structure her mortgage was over a nine-year period, at a rate of 1.46%. Hezekiah and his wife also each gifted Chandra $14,000, which is the maximum allowed under the IRS tax code. This gave Chandra a down payment of $28,000, making her monthly mortgage payment $182.50.
Hezekiah, who earned about $85,000 at the peak of his career as a State Farm agent, was able to put up the remaining mortgage balance in cash, due to a lifetime of careful financial planning.
“When I was 21, I set my first financial goal, which was to save $100,000 by the time I was 35. I met that goal when I was 35 and continued to save, invest, and build my wealth through stocks and real estate. By the time I retired, I had close to $4 million,†says Hezekiah.
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An Investment Vehicle for the Lender
Intrafamily loans not only
provide parents like Hezekiah a way to support children or other family members who prefer to avoid the checks, balances, and interest rates, they would be subjected to from traditional lenders, but they can also be a sound investment.In addition to the monthly mortgage payment, which is determined largely by the size of the loan, the lender is getting a rate of return on the loan that is higher than interest rates they would earn in investments such as money markets and CDs. “Our average rate in June was 2.91%. This can be a good investment option for parents looking to reduce some of the risk in their retirement savings and take money out of stocks, while still earning a return,†says Burke.
Interest rates are decided between the borrower and the lender, but they must be at least as high as the Internal Revenue Services’ Applicable Federal Rate, (AFR), which the IRS publishes each month as a guideline for assigned interest charges. The current AFR for loans that are nine years or more is 2.82%. It’s 1.82% for loans between two and nine years, and 0.48% for loans that are less than two years.
“I have good credit, but I do feel more secure knowing the loan is with my father, and the rates are better than I could find at a bank,†says Chandra. “I know what my payments will be each month, and I know that my most important asset is in the hands of someone who cares about me,†she adds.
Costs and Benefits of Intrafamily Loans
National Family Mortgage
charged the Webb’s a fee of $875 to structure the mortgage, as they do for all mortgages between $100,000 and $200,000. The fee rises to $1,075 for loans that are $300,000 to $500,000 and to $1,725 for those in the $500,000 to $1 million range. Loans that are more than $1 million cost $2,100.The company also charges $15 a month for its electronic payment service, which Burke says is the most popular payment option. Most payments are deducted on the first of the month. The borrower and lender also get a monthly statement and formal tax documents:Â A 1098 for the borrower and a 1099 for the lender.
The home itself is used as collateral for the loans, and liens are in place, although Burke says he has never had to enforce one. In addition, since the loan is secured by a registered mortgage, the homeowner can deduct interest payments from their taxes.
Know Your Customer
Intrafamily mortgages can become ‘houses of cards’ if the borrower is unable to honor their monthly financial commitment. In addition, doing financial transactions with family members can be risky business.
“The complexity of family relationships, combined with the emotional baggage and beliefs we hold around money, can make for a volatile combination,†says Rick Kahler, founder and president of Kahler Financial Group.
Kahler says one of the best features of intrafamily mortgages is that they can take a lot of the emotion and drama out of the ‘family money dynamic.’ “It is essential to execute formal documents, such as mortgages or contracts for deed. This emphasizes that the loan is a real transaction and a legally enforceable agreement,†he says.
As Kahler and other financial advisers point out, however, when it comes to doing any lending to a family member, keep in mind that being a lender of ‘last resort’ to someone who is in financial chaos is never a good idea.
3 Questions to ask before you enter into an intrafamily mortgage
Can you afford to make the loan? Always make sure your overall budgetary needs are met, and that you’re on track to meet your retirement savings goals before you even consider stepping into someone else’s financial life.
Can you and the borrower communicate directly and honestly? An inability to have an honest discussion about money is at the heart of many family disputes. Be honest with yourself about the level of honest communication you have with the borrower. Chandra says the fact that she and her father always had open and honest discussions about finances played a big role in how smoothly the transaction went.
What are you willing to do if the borrower fails to make payments? Not only is it important to pay attention to what the financial ramifications would be to your budget if the borrower missed a payment, but also consider what it would do to your relationship? Pay attention to the emotions that come up as you think about making the loan. Discuss this with the borrower before you make your decision, and be sure to ask them to give you a designated amount of advance notice if they think they will miss a payment.