Personal loan to a family member

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Abe
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Re: Personal loan to a family member

Post by Abe » Wed Jul 12, 2017 9:57 am

There is always the risk that you will lose money. I invested in mortgages for many years. Just because you have a lien on the house does not necessairly mean you will get your money back. Example: You hold a second mortgage for say $50k behind a first mortgage of say $200k. If there is a foreclosure, the first mortgage holder would probably bid $200k, just enough to protect their $200k investment. Unless another bidder bid more than the first mortgage, you could lose all or part of your $50k. In that case, the only way you could protect your second mortgage would be for you to bid $250k, in which case you would get the house. You may not want the house for $250k. If you hold a first mortgage, you will be in a safer position, but you still could lose money because the house may not bring enough to cover your first mortgage plus expenses. This is especially true if you make a 100% loan to value loan, that is the buyer doesn't have any money paid down. This is the way it works where I live. It may be different in another state. You really need to know what you are doing when you make a mortgage loan. There are a lot of things that could happen.
Edited to add: Also, you need to be aware the IRS may consider that you received interest even if the loan is interest free.
Imputed Interest refers to interest that is considered by the IRS to have been paid for tax purposes, even if no interest payment was made. The IRS uses imputed interest as a tool to collect tax revenues on loans that don't pay interest, or stated interest is very low.
Last edited by Abe on Wed Jul 12, 2017 10:28 am, edited 2 times in total.
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stats99
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Re: Personal loan to a family member

Post by stats99 » Wed Jul 12, 2017 9:59 am

Can you secure the deed? Or otherwise own the home until they can buy it back from you. I am sure there are tax issues but there are tax issues for an interest free loan, in that the difference between 0 and market rate is considered a gift.

DEZ1
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Re: Personal loan to a family member

Post by DEZ1 » Wed Jul 12, 2017 10:57 am

MathWizard wrote:I'm not sure why you would like to loan the money, but are worried about getting it back.

We loaned to parents, since what they gave us was much more valuable.

I have money to a brother who had helped me out.

I would loan or give money to kids if they needed it.

Short of life or death, which this isn't , I would not loan money if I had to have it paid back. If it was a sure bet that the money would be paid back, they could get a loan from a bank.

For my kids, if we make sure we have enough, they will likely inherit hundreds of thousands, so e.g. a loan of 20 or 30K which would be a lot , could likely easily be settled by the estate.

You haven't said who the relative, so I assume a sibling with a spouse or children. I wouldn't do it for further away than that, like a nephew. Given I've never had a new house, much less cost overruns on one, I wouldn't be inclined to help a nephew get something I never had.
Thanks for your point of view

DEZ1
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Re: Personal loan to a family member

Post by DEZ1 » Wed Jul 12, 2017 10:58 am

runner3081 wrote:Don't loan more than you are ready to give away and never get back.
:happy

DEZ1
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Re: Personal loan to a family member

Post by DEZ1 » Wed Jul 12, 2017 11:01 am

Swimmer wrote:I mean no offense, but have you asked yourself WHY you "would like" to make this loan?
A very close sibling

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Re: Personal loan to a family member

Post by DEZ1 » Wed Jul 12, 2017 11:02 am

Uncle Pennybags wrote:OP say;
I’m sorry, my good fellow, but all my money is tied up in currency.
W. C. Fields
This is the best line I have heard!

KlangFool
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Re: Personal loan to a family member

Post by KlangFool » Wed Jul 12, 2017 11:28 am

DEZ1 wrote:
Swimmer wrote:I mean no offense, but have you asked yourself WHY you "would like" to make this loan?
A very close sibling
DEZ1,

Don't destroy the relationship by giving a loan. Give him whatever amount that you can afford to lose.

KlangFool

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FelixTheCat
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Re: Personal loan to a family member

Post by FelixTheCat » Wed Jul 12, 2017 11:31 am

Do not loan money. Do not co-sign a loan. You are only looking for heartache if you do.
Felix is a wonderful, wonderful cat.

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jeff1949
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Re: Personal loan to a family member

Post by jeff1949 » Wed Jul 12, 2017 11:47 am

You have probably gotten good advice from those who have said not to go ahead and loan the money to this relative.

HOWEVER, you did not ask advice on whether or not you "should" loan the money but rather how to protect yourself IF you loan the money to him. My answer to this is: A SECOND MORTGAGE

A Second Mortgage with you as the note holder will do exactly as you have asked which is to protect you from the relative borrowing more money. With a Second Mortgage you will have the risk if the First Mortgage holder forecloses but you will be second in line and ahead of all other creditors if done properly and you do you due diligence which may mean getting to view the title report from the First Mortgage holder or perhaps paying for a second title report.

EDIT: I just noticed that "Abe" above has touched on the idea of a Second Mortgage and gave good info on it.
Last edited by jeff1949 on Wed Jul 12, 2017 11:52 am, edited 2 times in total.

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whodidntante
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Re: Personal loan to a family member

Post by whodidntante » Wed Jul 12, 2017 11:51 am

I wouldn't do it. I'm also dubious that you can give an interest free loan to a family member without one of you having tax consequences.

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Abe
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Re: Personal loan to a family member

Post by Abe » Wed Jul 12, 2017 11:57 am

whodidntante wrote:I wouldn't do it. I'm also dubious that you can give an interest free loan to a family member without one of you having tax consequences.
Imputed Interest refers to interest that is considered by the IRS to have been paid for tax purposes, even if no interest payment was made. The IRS uses imputed interest as a tool to collect tax revenues on loans that don't pay interest, or stated interest is very low.
Slow and steady wins the race.

Afty
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Re: Personal loan to a family member

Post by Afty » Wed Jul 12, 2017 12:02 pm

whodidntante wrote:I wouldn't do it. I'm also dubious that you can give an interest free loan to a family member without one of you having tax consequences.
I think if you want to do this properly, you'd have to handle "imputed interest" presumably as a gift to the family member. See
https://turbotax.intuit.com/tax-tools/t ... 28705.html.

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bottlecap
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Re: Personal loan to a family member

Post by bottlecap » Wed Jul 12, 2017 12:26 pm

Afty wrote:
whodidntante wrote:I wouldn't do it. I'm also dubious that you can give an interest free loan to a family member without one of you having tax consequences.
I think if you want to do this properly, you'd have to handle "imputed interest" presumably as a gift to the family member. See
https://turbotax.intuit.com/tax-tools/t ... 28705.html.
Yes. And then you pay income taxes on the interest you didn't receive.

Consigning for a second mortgage avoids the extra taxes, but exposes your credit. The mortgage holder won't let the consigner know about the delinquency until it is too late. Happens all the time.

JT

ddurrett896
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Re: Personal loan to a family member

Post by ddurrett896 » Wed Jul 12, 2017 12:47 pm

DEZ1 wrote:I am somewhat worried about getting it back.
Run - don't do it!

ETadvisor
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Re: Personal loan to a family member

Post by ETadvisor » Wed Jul 12, 2017 1:23 pm

whodidntante wrote:I wouldn't do it. I'm also dubious that you can give an interest free loan to a family member without one of you having tax consequences.
Yes you are correct. It is a below-market loan. See Publication 550 and IRC section 7872.

Bungo
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Re: Personal loan to a family member

Post by Bungo » Wed Jul 12, 2017 1:42 pm

Various family members have "borrowed" money from me over the years, adding up to tens of thousands of dollars. I've never received a penny of repayment. I closed the ATM for good about a decade ago. Relationships with the relevant family members today range from strained to nonexistent. If I could do it all over, I would have declined to lend money to anyone.

WildBill
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Re: Personal loan to a family member

Post by WildBill » Wed Jul 12, 2017 2:05 pm

Howdy

If you have decided to help your relative, my experience is that in general it is simpler and easier - and cheaper - to just give a relative the money rather than try to structure some sort of loan.

W B
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mouses
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Re: Personal loan to a family member

Post by mouses » Wed Jul 12, 2017 3:44 pm

I will add that if a responsible person, say your Mom or Granddad needs money to keep a roof over their head, of course give it to them and not as a loan. That's not what we're talking about here. We're talking a luxury item.

miamivice
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Re: Personal loan to a family member

Post by miamivice » Wed Jul 12, 2017 3:50 pm

I'm not sure I see many answers to the OPs question.

My understanding is that a relative needs money to finish a home. He has received a construction loan from a bank, but due to cost overruns, needs more money than the bank will lend in order to complete the house. The OP is interested in lending the money but wants to make sure that he is repaid in the event that the house is sold.

So, it sounds like the OP would be extending a second mortgage to the relative, junior to the construction loan that has already been issued. Should the house be sold, the construction loan would be paid off first as the senior loan, and then the family loan would be paid off as the junior loan. The OP can write up a deed of trust and record this with the county, and this would ensure that he would be paid before the house was sold.

The problem with this concept is that it sounds like the construction loan will be about 100% of the value of the house, and the family loan will exceed 100% of the value. Should the house be sold, the family member will have to bring cash to closing in order to pay the family loan, which is less likely to happen. In the event of a foreclosure, the construction loan would be paid off first and the family loan may never be paid.

That's my technical answer to the OPs actual question. I will leave comments about whether this is a good idea or not to others on the thread.

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Index Fan
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Re: Personal loan to a family member

Post by Index Fan » Wed Jul 12, 2017 3:56 pm

Don't do it unless you would give it as a gift. There are many many stories of money destroying family relationships.
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Abe
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Re: Personal loan to a family member

Post by Abe » Wed Jul 12, 2017 4:07 pm

miamivice wrote:I'm not sure I see many answers to the OPs question.

The OP is interested in lending the money but wants to make sure that he is repaid in the event that the house is sold.

So, it sounds like the OP would be extending a second mortgage to the relative, junior to the construction loan that has already been issued. Should the house be sold, the construction loan would be paid off first as the senior loan, and then the family loan would be paid off as the junior loan.
I posted on this upthread. Uh, is upthread a word? :happy
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nordsteve
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Re: Personal loan to a family member

Post by nordsteve » Wed Jul 12, 2017 4:24 pm

While I'm generally with the others on this thread that family loans should be considered gifts, I will offer this counterexample:

My parents, financially well off and not in need of the money, took a fully documented loan with mortgage on their cabin from my elderly grandmother. It was a much better interest rate than what my grandma could get on CDs, and it made a material difference in her living standard as she got older.

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wander
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Re: Personal loan to a family member

Post by wander » Wed Jul 12, 2017 4:49 pm

If you don't want to lose a brother/sister, don't let him/her borrow your money. If you let her/him borrow the money, there's a chance you will lose a brother/sister. You may not have problem with losing money but your spouse may have, and it may affect your own relationship.
Saying that, I do lend money to my sibling, it is out of love and my spouse supports it. There is no binding contract but a verbal agreement to pay the money back within some years.

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Re: Personal loan to a family member

Post by Wakefield1 » Wed Jul 12, 2017 4:54 pm

If it is a very large amount,necessary to complete the house,perhaps the approach mentioned earlier where the person being asked to put up the money as a loan,instead,pays for the completion of the house but having taken over as owner(bought the project/property),then rents the house back to the relative. Assuming that the person being asked to front the money can easily afford to do that without significant hazard to their own financial health. If the relative really wanted to own the house perhaps they would be motivated to save up enough to buy it outright some day.

BigLaw Survivor
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Re: Personal loan to a family member

Post by BigLaw Survivor » Wed Jul 12, 2017 5:21 pm

Here's one suggestion for you: https://www.nationalfamilymortgage.com/

I used this company a few years ago to help my daughter buy a house. She was fresh out of school and didn't have a long enough track record in the workplace to get a mortgage through a bank.

In a nutshell, they handle all the work in setting up a legit mortgagor/mortgagee relationship between a customer and a relative for "intra-family" lending. You have to charge market rate interest to avoid IRS gift tax problems, but if you're comfortable doing that they handle all the paperwork, file the lien on the property, collect the monthly payments (via automatic withdrawal/deposit to avoid awkward monthly conversations with the relative), etc. And when your relative goes to sell or refinance you're taken care of first, like any other first mortgage lender.

The only caveat -- which I just saw on their website -- is that they are doing so well they won't take any new customers until October. Still, I'd check this out and give it some thought. They did a great job for my daughter and me (she has since refinanced with a major bank and is now on her own).

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Re: Personal loan to a family member

Post by skepticalobserver » Wed Jul 12, 2017 5:42 pm

The legal mechanics of recovering money can get nasty and expensive. Might setting up a first mortgage involve HUD disclosures and the nightmares to follow if you don't dot the "i's," etc. You mention that this prospect has "overruns" on construction. Why wouldn't you be his next overrun?

Gift money to family--never lend or invest. Years after we still have strained relations over a four grand (bad) investment.

Let him find a hard money lender for a bridge loan and later conventionally refinance when he gets his life upright.

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randomizer
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Re: Personal loan to a family member

Post by randomizer » Wed Jul 12, 2017 5:52 pm

Run for the hills, or gift the money. There is no other way.

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Re: Personal loan to a family member

Post by JGoneRiding » Wed Jul 12, 2017 5:52 pm

Since it seems like op got min response to actual question.

This actually isn't that hard but you do have to charge a base extremely min interest rate per irs regulations (look it up but believe currently the rate is under 2%) then set it up with the lawyer or title company doing closing. And also set it up with a pay service so you aren't bad guy.

I bought with owner financing one rental, according to this board that guy was completely nuts for giving me the loan at only 10% down but it worked incredibly well for both of us and I refined in 2 years (I had 7 to do it but had promised to do it as soon as it reasonable made sense)

We had the closing done so I paid a company that handled all the yearly paperwork it cost 12/mos and sent statements and payment coupons exactly like a standardmortgage. Google it some of these exist exactly for intra family loan documentation

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8foot7
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Re: Personal loan to a family member

Post by 8foot7 » Wed Jul 12, 2017 6:14 pm

If the family member has a cost overrun then his loan to value ratio will almost certainly be very high which makes a junior lien very very weak and risky. This would not be the best course of action if securing repayment is a primary objective. Seconds get wiped out all the time, either effectively or actually, in foreclosure situations.

mega317
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Re: Personal loan to a family member

Post by mega317 » Wed Jul 12, 2017 7:06 pm

nordsteve wrote:While I'm generally with the others on this thread that family loans should be considered gifts, I will offer this counterexample:

My parents, financially well off and not in need of the money, took a fully documented loan with mortgage on their cabin from my elderly grandmother. It was a much better interest rate than what my grandma could get on CDs, and it made a material difference in her living standard as she got older.
This is interesting. Sounds like it worked out for everyone, but what if grandma needed or wanted the principle? It could have gone poorly just like OP's situation might, no? If the answer is your parents would have given it to her, then really wasn't it just a gift to grandma in the form of interest that your parents wouldn't have otherwise been paying?

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Uncle Pennybags
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Re: Personal loan to a family member

Post by Uncle Pennybags » Wed Jul 12, 2017 8:43 pm

mega317 wrote:
nordsteve wrote:While I'm generally with the others on this thread that family loans should be considered gifts, I will offer this counterexample:

My parents, financially well off and not in need of the money, took a fully documented loan with mortgage on their cabin from my elderly grandmother. It was a much better interest rate than what my grandma could get on CDs, and it made a material difference in her living standard as she got older.
This is interesting. Sounds like it worked out for everyone, but what if grandma needed or wanted the principle? It could have gone poorly just like OP's situation might, no? If the answer is your parents would have given it to her, then really wasn't it just a gift to grandma in the form of interest that your parents wouldn't have otherwise been paying?
Not getting a bank loan but borrowing from family to keep the interest in the family is not the same as family being the lender of last resort.

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Crimsontide
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Re: Personal loan to a family member

Post by Crimsontide » Wed Jul 12, 2017 8:46 pm

The voice of experience says " do not do it", unless you are prepared to lose it all, do not do it...

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catdude
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Re: Personal loan to a family member

Post by catdude » Wed Jul 12, 2017 9:50 pm

OP, see my signature below. Twain may as well have been speaking of family relationships as well as friendships.
catdude | | “The holy passion of Friendship is of so sweet and steady and loyal and enduring a nature that it will last through a whole lifetime, if not asked to lend money.” (Mark Twain)

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Re: Personal loan to a family member

Post by bnes » Wed Jul 12, 2017 10:00 pm

Yeah, I'm dealing with the version where the family member turned out to be a deadbeat, despite having a recorded official note and lien. And because the family wants the person to stay in the house (and not bum housing off yet other relatives), there's no leverage to resolve the situation. Consider a gift instead: less hard feelings. If you must do it, head first to Nolo Press ( http://www.nolo.com/ ) and get the right forms.

DEZ1
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Re: Personal loan to a family member

Post by DEZ1 » Thu Jul 13, 2017 12:26 am

BigLaw Survivor wrote:Here's one suggestion for you: https://www.nationalfamilymortgage.com/

I used this company a few years ago to help my daughter buy a house. She was fresh out of school and didn't have a long enough track record in the workplace to get a mortgage through a bank.

In a nutshell, they handle all the work in setting up a legit mortgagor/mortgagee relationship between a customer and a relative for "intra-family" lending. You have to charge market rate interest to avoid IRS gift tax problems, but if you're comfortable doing that they handle all the paperwork, file the lien on the property, collect the monthly payments (via automatic withdrawal/deposit to avoid awkward monthly conversations with the relative), etc. And when your relative goes to sell or refinance you're taken care of first, like any other first mortgage lender.

The only caveat -- which I just saw on their website -- is that they are doing so well they won't take any new customers until October. Still, I'd check this out and give it some thought. They did a great job for my daughter and me (she has since refinanced with a major bank and is now on her own).
Thanks for your advice, I will definitely look into this option.

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Re: Personal loan to a family member

Post by mega317 » Thu Jul 13, 2017 12:29 am

Uncle Pennybags wrote:Not getting a bank loan but borrowing from family to keep the interest in the family is not the same as family being the lender of last resort.
Yes absolutely. But if parents could have paid cash why not just do that and gift what would have been the interest? Then grandma still has her principle. Maybe I'm not properly thinking this through.
Last edited by mega317 on Thu Jul 13, 2017 12:30 am, edited 1 time in total.

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Re: Personal loan to a family member

Post by LarryAllen » Thu Jul 13, 2017 12:30 am

Don't do it now what's the question? :)

Seriously though been there and done that. Did an interest free loan for a family member. She paid when she wanted (not as we agreed), skipped some months, was not thankful, and in the end I felt like the bad guy for occasionally asking if we were getting paid that month. Also created spousal issues between my wife and I. Avoid it if you can!

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Uncle Pennybags
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Re: Personal loan to a family member

Post by Uncle Pennybags » Thu Jul 13, 2017 9:14 am

mega317 wrote:
Uncle Pennybags wrote:Not getting a bank loan but borrowing from family to keep the interest in the family is not the same as family being the lender of last resort.
Yes absolutely. But if parents could have paid cash why not just do that and gift what would have been the interest? Then grandma still has her principle. Maybe I'm not properly thinking this through.
I missed the part where a lone was not necessary. Strike that part and if a loan was necessary it would be better to keep the money in the family. That's how a family becomes "old money".

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Watty
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Re: Personal loan to a family member

Post by Watty » Thu Jul 13, 2017 1:51 pm

One thing that was not clear is how much equity that relative has in the house.

If they already had to put up 20% of the cost of the planned cost house and they could only finance 80% but then the cost overrun was 10% then there would be a margin of safety for you.

Helping them out is one thing but making it a zero interest loan is a very bad idea. You loan should be at a slightely higher interest rate (5%+ ??) to modivate them to pay you off first even if they have to refinance the house once it is done. You could give the interest back to them after the loan is paid off if you wanted to. You could even write it into the contract that the interest will be forgivien if it is paid off by a certain date.

One other thing that has not been mentioned is that you loaning them money could cause problems with their financing if their loan had to go through underwritting again when it is converted from a construstion loan to a regular mortage. I suspect this may not be a problem but they should make sure that anything they do is OK with their lender

They should also not have any other way to finance extra money that is needed. For example could they;
1) Get loans on paid off cars
2) Get a 401k loan.

Another option might be to cut back on some of the other features of the house if it is not too late for that. For example they may be able to put less expensive appliances in the kitchen or have smaller decks and patios. They could upgrade those later on when they have the money.

tampaite
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Re: Personal loan to a family member

Post by tampaite » Thu Jul 13, 2017 1:57 pm

DEZ1 wrote:I would like to make a large interest free loan to a family member however I am somewhat worried about getting it back. Since the purpose loan is to buy a home how do I set it up so that I can have a lien on the house until the loan is paid back. What else should I do to protect myself from a default.
Short answer - NO.
Long answer - NOoooooooooo but If you must, take collateral NOW in whateverform(Ex: Gold Jewellery)

I would only lend money to relatives if its life and death matter(as in getting medical treatment) otherwise, absolutely no way since I got my hands burned twice lending to close family.

bluebolt
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Re: Personal loan to a family member

Post by bluebolt » Thu Jul 13, 2017 4:28 pm

Be careful that you don't get labeled the bad guy despite trying to be the good guy. Easy to imagine a scenario where the sibling stops paying you back and he and the rest of your family members give you grief for being insensitive or for being a miser if you try to collect.

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Re: Personal loan to a family member

Post by GoldenFinch » Thu Jul 13, 2017 5:01 pm

Do you know your siblings credit score? It might be worth asking. If it's money you can afford to lose, the situation is different than if it's money you will definitely need. It is nice of you to want to help a sibling and smart that you're researching the potential pitfalls.

JGoneRiding
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Re: Personal loan to a family member

Post by JGoneRiding » Thu Jul 13, 2017 5:15 pm

tampaite wrote:
DEZ1 wrote:I would like to make a large interest free loan to a family member however I am somewhat worried about getting it back. Since the purpose loan is to buy a home how do I set it up so that I can have a lien on the house until the loan is paid back. What else should I do to protect myself from a default.
Short answer - NO.
Long answer - NOoooooooooo but If you must, take collateral NOW in whateverform(Ex: Gold Jewellery)

I would only lend money to relatives if its life and death matter(as in getting medical treatment) otherwise, absolutely no way since I got my hands burned twice lending to close family.

The collateral idea isn't bad. I knew someone who regularly took collateral in weapons. These can be worth a lot and are easily unloaded but people are very attached and generally want them back. He nearly never had to hock them people paid up. Depends on area type of course. Could also take a boat- something to use until paid off ;)

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Uncle Pennybags
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Re: Personal loan to a family member

Post by Uncle Pennybags » Fri Jul 14, 2017 9:07 am

Watty wrote:Another option might be to cut back on some of the other features of the house
I have been in many a "Mc Mansion" where only two rooms out of 20 were furnished.
Last edited by Uncle Pennybags on Fri Jul 14, 2017 9:32 am, edited 1 time in total.

colemanst13
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Re: Personal loan to a family member

Post by colemanst13 » Fri Jul 14, 2017 9:11 am

Have that person sign a note and deed of trust. Then, record the deed of trust. Do a title search first to ensure that you are in 1st lien position!

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Meg77
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Re: Personal loan to a family member

Post by Meg77 » Fri Jul 14, 2017 10:27 am

I am surprised at all the responses that insist this is a terrible idea with no good outcomes. Construction costs overrun budgets all the time (more often than not actually, which I can attest as a lender who does plenty of construction loans). Ideally clients have cash to cover that, but building a home is one of the most expensive projects most people ever take on - and between paying for alternate housing and construction and loan costs, usually liquidity tends toward a very low level, even among very affluent and wealthy borrowers. Most people only build one home in their lives, so they aren't experts at it. This does not necessarily indicate this family member is a deadbeat who is a poor planner.

You can absolutely lend this person money and take a second lien on the house as collateral. This does not necessarily ensure that you will get paid when he refinances though, only when the property is sold eventually. He or she could refinance the first lien without paying off the second. You should absolutely take a lien though. Doing so protects you and may also enable your relative could deduct the interest paid on the loan as mortgage interest.

One thing to note is that you may mess up your relative's ability to GET a permanent first mortgage depending on the amount you are lending and the value of the home. If the home is worth $250,000 and the construction loan is $200,000 (80% of the value, which is typical), then you could take a lien of up to $25K or so and still enable your relative to get a first mortgage that would roll both liens together and pay you off (a 90% mortgage). But if you lend $50,000, not only would a first mortgage not be able to pay you off, but it may be harder to get since lenders do consider the TOTAL LTV on a home, not just the LTV on their lien. It may not be a huge deal to some lenders, but it is something to be aware of. However if your relative obtained a "construction-to-perm" loan that automatically converts to a permanent mortgage when construction is complete, then there may be no refinancing to worry about.

The way to go about this is to engage a title attorney (just call any local title company) and ask them to prepare a deed/mortgage (some states call it a deed; others call it a mortgage) on the property. The title company will also do a lien search to verify that your lien will be in second place. Be aware though that if mechanics liens are filed by subcontractors who haven't been paid, or if property taxes are delinquent, those liens will be ahead of you even if they are filed later.

You'll also want to draw up a basic promissory note for your relative. You can mandate monthly payments or no payments, but you do want to charge the minimum level of interest required by the IRS (it varies, so ask the attorney or probably you can google it) or else your loan will be considered a gift and will mess up your tax planning. You can always forgive the interest if you want later, but you want to set up the loan to charge it. You can get a simple promissory note online, or pay a small fee for the title attorney or another attorney to draw it up and make sure it has all the wording required by your state. The whole thing should cost you $250 or less.
"An investment in knowledge pays the best interest." - Benjamin Franklin

michaeljc70
Posts: 1955
Joined: Thu Oct 15, 2015 3:53 pm

Re: Personal loan to a family member

Post by michaeljc70 » Fri Jul 14, 2017 10:34 am

Meg77 wrote:I am surprised at all the responses that insist this is a terrible idea with no good outcomes. Construction costs overrun budgets all the time (more often than not actually, which I can attest as a lender who does plenty of construction loans). Ideally clients have cash to cover that, but building a home is one of the most expensive projects most people ever take on - and between paying for alternate housing and construction and loan costs, usually liquidity tends toward a very low level, even among very affluent and wealthy borrowers. Most people only build one home in their lives, so they aren't experts at it. This does not necessarily indicate this family member is a deadbeat who is a poor planner.

You can absolutely lend this person money and take a second lien on the house as collateral. This does not necessarily ensure that you will get paid when he refinances though, only when the property is sold eventually. He or she could refinance the first lien without paying off the second. You should absolutely take a lien though. Doing so protects you and may also enable your relative could deduct the interest paid on the loan as mortgage interest.

One thing to note is that you may mess up your relative's ability to GET a permanent first mortgage depending on the amount you are lending and the value of the home. If the home is worth $250,000 and the construction loan is $200,000 (80% of the value, which is typical), then you could take a lien of up to $25K or so and still enable your relative to get a first mortgage that would roll both liens together and pay you off (a 90% mortgage). But if you lend $50,000, not only would a first mortgage not be able to pay you off, but it may be harder to get since lenders do consider the TOTAL LTV on a home, not just the LTV on their lien. It may not be a huge deal to some lenders, but it is something to be aware of. However if your relative obtained a "construction-to-perm" loan that automatically converts to a permanent mortgage when construction is complete, then there may be no refinancing to worry about.

The way to go about this is to engage a title attorney (just call any local title company) and ask them to prepare a deed/mortgage (some states call it a deed; others call it a mortgage) on the property. The title company will also do a lien search to verify that your lien will be in second place. Be aware though that if mechanics liens are filed by subcontractors who haven't been paid, or if property taxes are delinquent, those liens will be ahead of you even if they are filed later.

You'll also want to draw up a basic promissory note for your relative. You can mandate monthly payments or no payments, but you do want to charge the minimum level of interest required by the IRS (it varies, so ask the attorney or probably you can google it) or else your loan will be considered a gift and will mess up your tax planning. You can always forgive the interest if you want later, but you want to set up the loan to charge it. You can get a simple promissory note online, or pay a small fee for the title attorney or another attorney to draw it up and make sure it has all the wording required by your state. The whole thing should cost you $250 or less.
But if construction costs go over all the time, that should have been planned for. And that is typically for a remodel. New construction is usually done on a fixed basis and only will change orders change the cost. Unless the owner is trying to GC for himself. It doesn't sound like this is a few thousand dollars of cost overruns.

WL2034
Posts: 400
Joined: Tue May 21, 2013 10:36 pm

Re: Personal loan to a family member

Post by WL2034 » Fri Jul 14, 2017 10:56 am

Meg77 wrote:I am surprised at all the responses that insist this is a terrible idea with no good outcomes. Construction costs overrun budgets all the time (more often than not actually, which I can attest as a lender who does plenty of construction loans)...
This may be true, although I find it a bad sign that the borrower has no flexibility in his original budget. The biggest red flag for me is from the OP's first post: "I would like to make a large interest free loan to a family member however I am somewhat worried about getting it back." (emphasis mine).

Typically, people are so optimistic about lending to family members before things turn south. The fact that it is a) a large loan and b) OP is worried about getting it back from the very beginning makes me think things will likely turn out poorly. Perhaps I missed it, but did OP state why he is "somewhat worried about getting it back?" Perhaps there are other red flags here.

robertalpert
Posts: 444
Joined: Wed Aug 22, 2007 10:09 pm

Re: Personal loan to a family member

Post by robertalpert » Fri Jul 14, 2017 11:37 am

Watty wrote:
I would think that it would be better to buy the house in your name then let them rent it from you.
+1

michaeljc70
Posts: 1955
Joined: Thu Oct 15, 2015 3:53 pm

Re: Personal loan to a family member

Post by michaeljc70 » Fri Jul 14, 2017 12:01 pm

WL2034 wrote:
Meg77 wrote:I am surprised at all the responses that insist this is a terrible idea with no good outcomes. Construction costs overrun budgets all the time (more often than not actually, which I can attest as a lender who does plenty of construction loans)...
This may be true, although I find it a bad sign that the borrower has no flexibility in his original budget. The biggest red flag for me is from the OP's first post: "I would like to make a large interest free loan to a family member however I am somewhat worried about getting it back." (emphasis mine).

Typically, people are so optimistic about lending to family members before things turn south. The fact that it is a) a large loan and b) OP is worried about getting it back from the very beginning makes me think things will likely turn out poorly. Perhaps I missed it, but did OP state why he is "somewhat worried about getting it back?" Perhaps there are other red flags here.
I agree. If the bank won't give the brother the loan (or increase the existing loan) and the OP is worried his brother will pay him back it isn't a good sign. If the brother cannot cover the cost overruns, how can he cover other unexpected future financial things that might happen like an expensive car repair, medical issue, etc? What if the property taxes wind up higher than anticipated?

There is no way to ensure OP will be paid back unless they can get free and clear collateral that has a stable value to cover the loan.

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