Can I Give Family and Friends a Home Mortgage Loan?

Most first-time homebuyers need a mortgage. Typically, you will get a mortgage from a bank, credit union, or other licensed mortgage lender. But what if you know an individual, such as a close friend or family member, who wants to offer you that mortgage loan?

Getting a family mortgage loan can be a great option for first-time buyers. However, potential buyers should understand the risks involved with loans through loved ones. If you have concerns about getting a private mortgage and how to protect your investment, talk to a local real estate attorney.

Understanding Private Mortgage Arrangements

Family and friends can help prospective homebuyers with a loan, gift, or by co-signing a mortgage. A private mortgage through friends and family is a loan for purchasing a home. Generally, these types of private mortgages from family and friends occur in one of the following situations:

• A lender has money they want to put to work, and they know someone in need of a mortgage loan
• A borrower has difficulty getting a conventional loan and knows someone privately who’s willing to offer the loan

A private arrangement may be more flexible than conventional mortgage and loan programs. For example, family members can give a loan when the buyer’s credit score or personal finances would not qualify for a loan. Family members can also give interest rate below the market rate or offer the loan without a mortgage down payment.

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Down Payment Gifts or Intrafamily Loans

All parties should understand the repayment terms and what happens if the borrowers cannot pay back the loan. If family offers to gift money for a home purchase, the gift amount should be free from restrictions. Even gifts are subject to gift tax limits and may require an IRS gift tax return.

There are limits on the source of gift funds if the borrowers use, for example:

• USDA loan
• VA home loan
• Federal Housing Administration (FHA) loan

Some down payment gifts can only come from certain people or groups, like family, charitable organization, or labor unions. Before transferring money for use as a down payment gift, you may need to document the bank account transfer with a gift letter.

If family want the home loan repaid, the parties need a loan agreement, with clear terms and conditions for repayment or possible default. Using a traditional loan agreement can help make sure you include all the standard terms. Include the loan amount, terms for regular mortgage payments, and interest rate. Your contract may require payment in full for missed payments and possible foreclosure or forced sale.

Mortgage Licensing Requirements and Exemptions

Loaning money to someone isn’t necessarily an issue, but friend and family loans can raise concerns when you’re taking a mortgage against the borrower’s principal residence, notes Sarah D. Cline, a real estate attorney at Miles & Stockbridge in Frederick, Maryland.

In some states, residential mortgage lenders must have state licensing. However, there are exemptions. For example, in Maryland, a lender can be exempt from the licensing requirement if they are:

• An employer making a mortgage loan to an employee; or
• A person making a mortgage loan to a borrower who is the person’s spouse, child, child’s spouse, parent, sibling, grandparent, grandchild, or grandchild’s spouse.

If you don’t fit within one of those types of loan definitions? “Essentially, for the lender, it’s illegal for them to make the loan if it doesn’t fall under one of these exemptions,” Cline says. Consult your local real estate laws before starting any property transaction.

Legal Trouble Can Arise When the Relationship Between Lender and Borrower Isn’t Clear-Cut

Where some homeowners and lenders get caught up is when those relationships aren’t as clear-cut as they seem. Cline recalls a refinance situation involving a retired attorney and his longtime secretary.

“She was in the process of refinancing her home and had some issues. He had some money, and he was willing to make a loan to her, but he definitely was not her employer any longer. The other issue was that even when he was her employer, he individually was not her employer; the company that he worked for was her employer. So I had concerns for both those reasons that they did not fall within that employer-employee exemption currently.”

Another relationship that can fall into a grey area is stepfamily. “Part of the problem we have with these exemptions is that none of the terms are really defined,” Cline says. “If you go to the definition section [of the law], it doesn’t define any of these relationships.”

Why Consulting a Lawyer Is Critical in Personal Loan Agreements

If you’re considering a family residential mortgage loan, Cline recommends consulting a lawyer. An attorney who’s knowledgeable in real estate law can protect you from potential problems later on. “For this type of transaction, it’s not, in my opinion, worth the risk of trying to do it yourself and document it yourself.”

“If I’m advising a client who’s looking at making one of these loans, I want to make sure that they are doing it wearing a white hat. I know that this is a consumer protection law,” Cline says. “And if it’s going to be enforced, it’s going to be enforced in favor of the consumer.”

The law doesn’t require specific documentation for a private loan. However, in many cases, the same Fannie Mae and Freddie Mac forms used by conventional lenders will work for private lenders. “They’re the consumer loan documents that the courts are most familiar with seeing,” she says. “They’re very consumer-friendly the way they’re written; they’re easy to understand.” A private loan is also bound by usury laws, which place caps on interest rates.

“The important takeaway is that if you’re thinking about lending somebody money secured by their residence, then you definitely want to call an attorney before you do anything in the state of Maryland,” Cline says.

Contact a Real Estate Attorney for Legal Advice

When personal home loan agreements go wrong, it can have costly financial consequences. Loan issues can also permanently harm family relationships. With proper planning, documentation, and legal counsel, you can avoid many of these issues. Talk to a local real estate attorney to protect your relationships and investments with a family home mortgage loan.