Geordie McGarty had a mortgage problem in Seattle. Like many other first-time home buyers, he struggled to get through all the underwriting hoops lenders require for a loan approval these days.
But McGarty’s specific problem was different from most. Because he had lived and worked in Japan for the past 16 years and made virtually no use of the American credit system, he looked like a blank slate to lenders. There just wasn’t much to go on in his national credit bureau files. He was a big question mark in terms of credit.
When he went to apply for a mortgage — even though he had cash for a down payment — loan officers balked. And because he had worked in the Seattle area in well-paid contract jobs with companies like Microsoft and Amazon for only a relatively short period of time, he didn’t have the IRS W-2 forms lenders typically want to see to document that an applicant has had steady employment for two years that is likely to continue.
The solution? McGarty turned to an idea that is rapidly gaining in popularity across the country: Peer-to-peer lending focused on mortgages. With the help of a company in Massachusetts that facilitates what’s called “intra-family” financing, he and his mother custom-tailored a mortgage package that got him the house he wanted and simultaneously provided a safe investment for his mom that earns her interest every month at a rate well above money market or Treasury bond yields.
What is Intra-Family Financing?
Though there are plenty of peer-to-peer lending sources around — Prosper and Lending Club are among the best known — McGarty sought out National Family Mortgage. It’s the only company that specializes in home loans among family members and handles the entire process — the upfront paperwork blitz, the recordations required by local governments, and the ongoing servicing functions of collecting and keeping track of payments. During the past several years, National Family has facilitated nearly a quarter of a billion dollars worth of loans ranging from $11,000 to $1.6 million, according to CEO and founder Tim Burke.
The core concept is quite simple. If you have immediate relatives — parents, grandparents, siblings, spouses, stepmothers, stepfathers — who have resources that could contribute to a first or second mortgage, but who aren’t in the position to simply gift it to you, they may be willing to lend you the money using your new house as security that you’ll pay it all back plus interest.
The key is to make the deal a win-win. For the relatives making you the loan, there is good money to be made. Rather than the miniscule amounts of interest (half a percent per year or less), they may now be earning on money market or banking deposits. A mortgage investment in your house could earn your relatives much better returns, say 3 percent to 3.5 percent.
The benefits to you are obvious: You get to own a house that should grow in resale value over the years. You typically get an interest rate that is below what banks are charging. And you get to claim mortgage interest deductions on your federal taxes, as long as the loan itself has been properly documented and the mortgage company reports your interest payments to the IRS.
How Does Intra-Family Financing Work?
Here’s a quick primer on how intra-family financing works, plus some tips on a couple of the potential downsides. Say your parents or grandparents have bank or money market assets that they could comfortably tap into to help you buy a house.
They have two main options: they could gift you all or a portion of the down payment you need for a standard mortgage. Or they could become the “Bank of Mom and Dad” and extend you a fully documented mortgage in the amount you need to buy the house you want.
The loan could be custom crafted: no down payment needed if you don’t have a lot of cash on hand, no credit checks or underwriting hassles, no title insurance or costly lender fees, plus monthly payments at whatever interest rate both sides mutually agree upon.
Note: to avoid gift tax problems, the rate needs to be at least equal to the “applicable federal rate,” currently a little above 3 percent for a 30-year loan.)
If you use National Family Mortgage (NFM), expect to pay a one-time fee of $750. For this, NFM will create the legal documents necessary to record the promissory note; provide the deed of trust or mortgage forms in the jurisdiction where you are purchasing the house; coordinate with your closing agent and register the mortgage as a lien against the property.
For $15 a month, National Family Mortgage will set you up with its servicing partner, who will manage the loan — sending monthly statements to you, offer electronic payment processing, escrow accounts and report to the IRS to ensure your interest is fully tax-deductible.
The Potential Downsides of Intra-Family Mortgage Loans
Are there potential downsides to getting a mortgage from close relatives? Of course. Money matters within families can be tricky and painful, especially if you pay late or fall far behind. You’re not dealing with some far-away, impersonal bank. You’re dealing with Mom, Dad, grandparents, loved ones.
A default can affect a lot more in your life, and for far longer, when the banker is a blood relative. As a practical matter, according to Burke, only 1 percent of loans serviced by his firm go into default. But when it happens, it can be a wrenching experience for the entire family.
Another drawback: For a variety of reasons, NFM cannot report your payments to the national credit bureaus — Equifax, Experian, and Trans Union. So your stellar payment performance on your intra-family mortgage won’t show up in your credit files, as it would with a traditional mortgage.
If neither of these considerations is a deal-breaker for you, and you have close family members who are capable and willing, go for it. An intra-family mortgage could be a great way to fund your house purchase and potentially provide a profitable investment for your relatives.
Kenneth Harney is a nationally syndicated columnist on real estate for the Washington Post Writers Group. His column, the “Nation’s Housing,” appears in cities across the country and has received numerous professional awards, including multiple Best Column-All Media awards from the National Association of Real Estate Editors and the Consumer Federation of America’s Consumer Media Service Award for “invaluable and unique contributions to the advancement of consumer housing interests.”