When borrowing a smaller amount from family, say 25k, for a downpayment, is it at all common to do a 30-year ammortizing loan? If so, what rate? Is 7.5% 30 year ammortizing reasonable? I want it to be attractive to them and at the same time affordable for me.
What is the term of the loan? I've borrowed various sums of money for various terms and we typically do an interest rate payable either monthly or annually. It's generally best to keep it simple and outline the payment amount and frequency. You really don't even need an interest rate if the loan agreement outlines the loan amount, repayment terms and frequency.
For example, I've done a loan with payments of 1% each month - the agreement just said I borrowed X and will pay .01X on the 5th of each month until mm/dd/yyyy. At that time X will be returned to the lender.
An amortization is definitely not necessary. Banks/lenders use amortization to get more of your money up front so if you refinance/sell they get a much higher return.
-Michael
Matt Liu:
It's a private loan, you can set whatever terms are comfortable for both parties. Is the family member insisting on principal repayment during the term or would they be content with interest payments and a return of principal at the end?
The family member is flexible. I just am worried that I won't be able to come up with the money to return the principal in 5 or 10 years even. So I'm wondering if ammortizing it is a good way to go for me to slowly pay it off.
The main thing is to communicate with your family about your intentions. I just setup a personal loan with ballon payment after 3 years (but intend to pay it off after 1). Personal loans are really easy to roll over to a new loan as well so you can change terms part way through the 30 years if you want or to some sort of rolling shorter term loan. Main thing is how much you trust your family to be ok with this and how well you communicate.
7.5% is well above the AFR minimum rates, so you wouldn't have an issue, but definitly make sure to understand the Applicable Federal Rates (http://apps.irs.gov/app/picklist/list/federalRates.html). These matter more on the longer term loans as the rates are higher.
In gereral I would say a safe place to think about starting with an interest rate is half way between what they would make on a CD and what a bank would charge you for the loan.
Matt Liu:
The question is, will you have built enough equity in 3-5 years to enable you to refinance to repay the family member w/o having to put any other monies forward. I would perform that analysis and, it possible, put such a plan in-place.
Is this a down payment for a personal residence?
If not and you're buying a rental property and need 25K that you don't think you'll be able to pay back in 5-10 years, then perhaps you need to re-evaluate the property you're looking to purchase or your reasons for purchasing it.
I would not invest in any property that I did not expect to recoup my initial investment within 5 years. I expect to get all of my money back within 1-2 years depending on the shape of the property when I purchase it.
Well if I took all of the net cashflow over the next five years - yes, I would be able to pay the loan off. But I was counting on that cashflow for other things.That's why I'm wondering if it's normal to set up the private loan for 30 years or 15 years amortizing, so that I gradually pay it off, and still have monthly income the whole time :)
Roy, very good question. The property I am buying is in a flat market. So the only way I can refi later to totally cash out my family, would be after a good 10-15 years of mild appreciation and ammortization of the bank loan.
Matt, I was leaning along the same lines as Michael.
I would not go longer than 3-5 yrs with a private lender, especially family.
Is there other, more traditional, financing planned for this property? If so, you should be able to pay it down sufficiently in 3-5 years, along with improving the performance of the property, to be able to refinance and pay the private note.
So you're taking out a loan to buy something and using the proceeds to buy other things for yourself rather than paying the loan back...This sounds like a terrible deal for whoever is making the loan to you.
Since you've already earmarked your future income for future purchases, you should probably just determine how much you are willing to fork over each month or year. Then determine how many years it will take you to pay the loan back at the lowest interest rate the lender will agree to.
You make a good point. Okay, I'm sold on the 3-5 year family loan, and will try to pay it all off before using the cashflow :)
I'm thinking I may I borrow 20k and in 5 years pay back say 25k. That means I will also have to tuck away 5k every year, which is almost all my cashflow! Oh well.
Great! I would recommend making monthly payments or annual payments that accomplish that goal. So you could either agree to make 60 monthly payments of $415 (416.67 if you want to be exact) or 5 annual payments of $5K.
The monthly payments will be a heck of a lot easier than the annual payments, so I'd recommend that. It does suck committing that much money to something each month, however you're much better off doing so to acquire a rental property than a new car :)
Matt Liu, borrowing money to use as a down payment with a requirement to pay it back may prevent the senior financing from qualifying you. The lender will source and season the funds you use as down payment and for closing costs. You and your family member who provided the loan will be asked to sign an affidavit that the money is not required to be paid back and is a gift. Lying about the loan and saying it is a gift, when it is not, is fraud.
In the same case, you would not be able to secure the loan from the family member by the real property as the senior lender will look to ensure a second position does not encumber the property. If you record a loan or lien after the purchase, the senior lender may call your loan due for violation of the loan terms.
If this is an investment property, gift money is not allowed in conventional loans. If you need $25k for the down payment, do you also need 6 months reserves to qualify?
If this is to be a loan, then the first position loan amount plus the $25k loan amount will be added to create your CLTV (Combined Loan To Value). In that case, the family member loan can't be used to cover closing costs, only the purchase price. You would have to make the up difference in the down payment for the CLTV restrictions and the closing costs.
I hate to be the black cloud, but I am not sure you fully understand your financing situation well. You might want to square that away before you run down a road that doesn't exist.
Dion beat me here, he touched on the lending issues, besides that; ...
Second question in a few days asking about borrowing from family. Search my posts and you'll find some blazing responses.
I assume you want to borrow and make it affordable for you, with decent terms and don't want to cause problems for the family lender either.
Seems everyonr thinks money in the family can just be a very casual thing, it can be, most often it's not wise to do so, unless it's small insignificant money to the family.
Things happen in life, people die, they can become incapacitated, disabled, heck, I know a guy who got in a car for a ride and ended up in jail! You have no idea what the future holds.
Next, there are lending requirements in RE. You can buy with gift money, but before you borrow or sign a contract to buy, know what a lender will allow. You can't just go borrow the entire down payment for the better loans.
More about future lending, refinancing and paying off existing loans and liens goes to 90% of the appraided value after one year. Cashing out on a loan is limited to 75% of the appraised value after one year. That means that if you do any casual loan thing and need to pay the loan off, all you can get is up to 75% of the value of the home. If you do the loan as a lien/mortgage on the property, the lender will go up to 90% of the value and payoff the old loan at closing. So.....dah.....file a lien!
Filing a lien, making it a formal transaction also means that the debt or asset will be covered by law in other issues like death, bankruptcy, etc. If you make a casual loan and you get killed in a car wreck your family is unsecured in the estate, they could lose thier money. File it as a mortgage and the money at sale will go to them.
Amortize the loan, make it good for both parties. You deduct interest paid if you itemize. Thet have interest income.
I'd suggest you be more concerned at earning income and keeping good credit than appreciation so you can qualify to borrow 90% of the value, you may get there with 10% equity in as little as 3 years, probably 5 years, you'd have to screw up not to get that in 10 years IMO. Just be careful on the property you buy, good location, good condition and a good price, you should be fine. Good luck :)
I am currently negotiating with a seller on a property I am looking to buy. He has agreed to carry back some amount of my down payment. I plan to purchase with a conventional loan, 25% down.
I spoke to my lender about this and he said that Fannie Mae does not allow 2nd liens in the purchase contract (makes sense), but after closing I am allowed to get a 2nd lien on the property. Basically once they underwrite it they don't care what you do after. This struck me as odd and a bit crazy but that was exactly what he said. Is he misinformed, or does this vary from lender to lender?
Thing is, I am perfectly qualified, can close with my own funds, but the deal would be much sweeter if he can carry something back.
Thanks.
Let's not get off topic, but fannie has always allowed 80% or 75% with 10 0r 15% down and a seller second of 10 or 15% down, that would be news to me, it can also vary with the investors buying the loan as well as by the lender, they may not want to fool with it. :)
Bryce Y., Bill is right, Fannie/Freddie loans allow seller carry backs. Its the originating lender who may have an overlay which precludes that type of structure or reduces the CLTV to 90% or less depending on occupancy and borrower qualification.
As far as a lender not caring what you do post close, not true. If the loan program has a CLTV restriction and by putting the Seller's lien on post close you exceed that CLTV, the loan is defective and could trigger acceleration. The loan will be checked, so saying nobody looks or cares is simply false. They may or may not do anything but if it is within the terms of the note and security instrument, they have a right to act in accordance with those terms.
So you're buying a property in a "flat" market and you don't see the value of it being 30% more in the next 5 years than what you're paying for it today?
Thats what I'm missing here. Are you paying retail for this house?
If so, why? Since you say its in a flat market, to me, that means in a not so great area.
Why would you pay retail in a bad area? Bad areas are typically the ones that offer a lot of foreclosure opportunities where you can pick them up for 50 to 60 cents on the dollar.
Something isn't quite right if you're buying in an area that isn't going to go up in the next 5 years AND you're paying retail for it to boot.
If the house will appraise out at 100k, you should be able to buy it for 70k all in (i.e. purchase plus rehab estimate). If not, maybe 80k tops. But any more than that, and it doesn't make sense.
So if you're paying 70k and borrowing 25k from family for the down payment and rehab, that would leave you with a loan of 45k. After 6 mos or a year, you should then be able to refi that at up to 70% LTV or 70k (assuming flat market and it doesn't go up) and be able to pay off your family and still own the home and the cash flow.
Maybe the better question isn't what rate the loan should be but how this deal actually looks in terms of the numbers (LTV, cash flow, etc).
So just to recap, I want to actually avoid doing ammortization, and should prefer INTEREST ONLY for about 5 years, and at which point, there should be some equity to refi and pay off the family loan.
That is a GOOD lesson for me. I realize now that an ammortizing loan at a high rate is very expensive! When it's a high rate (as in private money) you want to do just interest only 'till you're able to refi out and use conventional (cheap) rates instead.
Matt Liu:
In essence, yes, but 5-yrs would be long for a private balloon loan.
Now, one detail I missed in your original posting, but was caught by the venerable eyes of Dion DePaoli and Bill Gulley, is the amount you are talking about borrowing from family is to be used as the down payment on an investment property. If this is true, you will likely encounter other problems with financing the purchase.
Here in Canada, you are not permitted to borrow the down payment on a property - it has to be your own monies or gifted to you (with no expectation of repayment). This may also be the law where you reside, but even if it is not, most conventional lenders will have convenants in their mortgage subscription terms which will not allow it.
Now, if it is the case that the family member(s) are providing a loan for the entire amount of the property purchase, then the loan is private and if both parties agree to a 5-yr term w/ interest only payments, that is fine ... they effectively become the mortgagee. Be certain to have your lawyer draw-up a formal contract as would be the case with any private lender.
I would also ensure that you make a "principal" payment into a holding account (high interest, GIC, money market) each month so you have the necessary cash on hand to retire the balance of the balloon loan when you refinance to a conventional mortgage in 3-5 years ... unless the value of house appreciates substantially in that time period, you will not be able to place a mortgage for your entire purchase price. The key to making this approach work is the discipline to set this capital aside and leave it alone.
That is a GOOD lesson for me. I realize now that an ammortizing loan at a high rate is very expensive! When it's a high rate (as in private money) you want to do just interest only 'till you're able to refi out and use conventional (cheap) rates instead.
I assume and hope that anyone giving you a "loan" will consider the circumstances.
As Roy mentioned you can have a "sinking fund" to retire your debt or reduce it. Most won't succeed doing that, the younger the borrower the greater chance of failure.
You can't rely on property values going up to give you the necessary equity to refinance in 5 years, I suggest you not even think along those lines, that is a big gamble.
SInce it's family, I guess they aren't wanting 12%, but what you need to look at is how much needs to be paid down to get you (really at 20%) to the loan to value to qualify for that end loan in 5 years. You can borrow at a low rate, it would then be best to amortize the loan at a payment amount that gives you the necessary equity needed.
I'd say most who get familiy money (and knowing from experience) make it easy on themselves with what might be good intentions but fail to live up to expectations. I have also seen younger borrowers have the attitude that, oh well, uncle Joe or daddy won't foreclose on me and two hours later not think much of it just saying, okay, we can redo this or I'll start paying more. I've even seen children not even make payments as agreed later on, getting behind and then start paying something.
Family loans are bad business! Then, when it's time for daddy to get paid off the child comes in and has no proof of payments and when that is obtained they can't qualify because they relied on daddy's love and affection instead of good business practices. So both have issues.
I have kids, please don't tell me they are financially mature and responsible right out of the chute, some might be, but it's rare. Kids grow up relying on family, that's what they know best is how to taken care of.
At some point, most stop using family, some never do.
If you are serious about not using your family and thier money, then design the loan so that it does what is required to do. If you're looking for theories of money management that could work that require more attention and judgment, that might work if you do something, my bet is that your interest only plan will fail in reality,.
Now, if you are 45 and have a mature grasp on your financial obligations and feel like the last person on earth you would ever fail to pay would be that family member, then perhaps some interest only plan would work.
So, I suggest if you really want to live up to what you propose, amortize the loan so that the equity will absolutely be there. Yes, that's harder to do, the payment will be higher, like I told my boys.....Man Up! If you don't hold kids responsible they can't learn. :)