Mortgage Options: Patronizing the Family Bank

In a time of choked credit and painfully low CD rates, some home owners and their parents are cutting financial institutions out of the mortgage picture and banking on each other.

In a time of choked credit and painfully low CD rates, some home owners and their parents are cutting financial institutions out of the mortgage picture and banking on each other.

The Bank of Mom and Dad can earn 4% or 5% on cash savings by holding the mortgage on the kids’ property. This symbiotic lending gives parents a source of income that beats the rate of return of, say, a money market fund. For younger folks who need a loan, it’s a good way to secure hassle-free financing at a reasonable rate.  

Of course, this family lending only works if Mom and Dad have enough cash to make the mortgage, and the kids have the wherewithal to make monthly payments. But if viewed and conducted correctly, family lending is a win-win arrangement; if not, Sunday dinners will be awkward!

A dentist friend of mine in Maryland holds the paper on both his kids’ homes. His children were looking for mortgages; his savings weren’t earning much; so he gave them mortgages at 4%, nearly a point below what a bank would have charged, but more than triple what he was earning on his savings.

“It helped both of us,” he says.

My husband and I have been loyal customers of Gordon Savings and Loan since my mother-in-law was widowed 19 years ago and struggled to maintain her lifestyle on safe, fixed-interest investments.

Through the years, we’ve paid Mom between 4% and 9% on the interest-only mortgages she’s held on our home and investment properties. At times, we’ve given her a point higher than falling mortgage rates because, after all, she’s our mom, and without that extra income we’d have to kick in anyway.

At the end of the loans, she retrieves her principal with her assets — and pride — intact. If she were to die before, the loans would become part of her estate.

These loans work for us because we don’t:

  • Beg banks for loans.
  • Pay points.
  • Spend extra money on property appraisals, credit checks, and bank processing fees.

We’d rather miss a limb than miss a payment; and Mom would rather cash our checks then ask her other kids for money. So, all in all, it’s worked well, but not without a few hiccups.

When the economy collapsed, Mom got nervous. During a pasta dinner, she handed us a letter that expressed her love and called her loans.

Dawn Rickabaugh, a Los Angeles financial consultant who specializes in the secondary private mortgage market, says we should have included in our deal an escape hatch that allowed Mom to sell all or part of the loans to a third party, just like banks do.

“Parents have to think like a bank and have an exit strategy,” says Rickabaugh.

In the end, we rejiggered things and repaid some, but not all, of Mom’s loans.

Here are some lessons we’ve learned about family loans:

  • Document loans completely and professionally. Settlement companies can draw up the mortgage, or you can use services, such as www.LendFriend.me, which structure, document, and manage loans made among family and friends.
  • Consider solutions to worst-case scenarios. What happens to payments if a child loses their job or divorces? Under what circumstances can the loan be recalled? A lawyer or mortgage writer can help you answer these questions.
  • Make sure borrowers, aka “the kids,” are financially stable and have equity in the property. They may have to save a little money before they qualify for a family loan.
  • Remember that real estate isn’t particularly liquid. If you think you’ll need your investment money soon or quickly, don’t make a long-term mortgage.

Have you ever given a loan to a family member? How did it work out?