Two of our rentals have about 10 years left on them at 4.875% - refied 5 years ago on a 15 year term. These rentals have been in service for years and cash flow nicely. I recently set up a trust for my mother which now needs to be invested in something better than a money market. My thought was to kill 2 birds and pay off the properties with some of the the trust funds and a private note back to her. All told would only be about 90K. Any advice on this? The things holding me back would be drawing up the note properly for her and hopefully getting a note servicer to handle the monthly payments properly etc.. I have zero experience with private financing. Feel free to tell me that this is a dumb idea as it's only an idea at this point. The thought is I'd be much happier paying my mothers trust than a bank. Paying her 2.5 or 3% with no closing costs would also obviously benefit me. Seems like a win-win when you look at the interest rate she gets from the bank. I want to get comfortable with notes and I think this would be an interesting way to get started. Any advice would be appreciated.
I would talk to a lawyer about legality/arms length rules.
With relation to a loan servicer - in our area, I believe the best option is SLS Loan Servicing but I have never used them and can't provide an opinion either way.
Paperwork is fairly straightforward. If you have ever used HM, then you could just copy it (with their blessing). I have an attorney in town that could help.
2-3% is a low rate for real estate. To be fair, I'd look at something higher, but under your current rate. You're only talking a few thousand with such a low loan amount.
It is probably $100-150 to have the paperwork drafted by a lawyer just decide what the term are in advance.
You will need a note (the loan) and a mortgage / deed of trust (securing the loan). It is important to make sure you do both, if you got sued and only had the note you could lose the house and your mom would have no claim. With the mortgage anyone trying to sue would see the recorded mortgage to your mom (make sure to record it) and see that there is reduced equity - that might deflect a lawsuit in itself.
If she is lending to you below the market rate the difference is considered a gift and will count against the annual gift limit.
I would suggest paying her the market rate. After all it's your Mom.
I would NOT recommend SLS. I would recommend Madison Management out of NJ as they do a lot of servicing on all types of loans...
Thanks for all the help and direction guys. From what I've read it looks like I'd be in the 3-9 year range. I had no idea the IRS had minimum rates to charge for loans like this.
Copied this from some of the material I found:
There are three AFR tiers based on the repayment term of a family loan:
(1) Short-term rates, for loans with a repayment term up to three years.
(2) Mid-term rates, for loans with a repayment term between three and nine years.
(3) Long-term rates, for loans with a repayment term greater than nine years.
A Lender should assess two main factors when selecting the appropriate IRS Applicable Federal Rate for a family loan:
(1) The length of the agreed upon repayment term of the loan.
(2) The IRS Applicable Federal Rate for that repayment term during the month in which the loan is made.
The IRS Applicable Federal Rates change monthly and are usually made available on the IRS’ website during the third or fourth weeks of the preceding month. However, loan parties are effectively “locked in” at whatever appropriate AFR is in effect at the time the loan is made. Generally speaking, these rates are significantly lower than market rates offered by a bank. See IRC Sec. 1274(d)
If a Lender chooses to simply not charge a family member a rate of interest at least equal to or above the appropriate Applicable Federal Rate in effect at the time a family loan is made, the IRS may impute the interest by taxing the Lender on the difference between the Applicable Federal Rate and the interest rate the Lender actually charged.
Short-term IRS AFR Rates - For Loans Up To 3 Years
@Chris Billington the Colorado Real Estate Commission has standard forms for the promissory note and the deed of trust. The main folder for the forms is located HERE. Obviously legal advise as to how to complete the forms would be advisable but it shouldn't be a lot to have that done.
Something else to consider with your mother's money is liquidity. If she were to need the money, make sure you have a way to get it to her reasonably quickly. Hard money loan as plan D might be in order.
Hey Bill a tad and a half late but, thanks for this info! I sure do appreciate the link.
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