With Interest Rates on the Rise, More Home Buyers Turn to Family-Backed Mortgage Loans — Here’s What You Need To Know
This is not the most opportune time to buy a home, with home prices hovering near all-time highs and mortgage rates on a steady rise. Average mortgage rates for a 30-year loan were 5.54% as of July 21, according to the St. Louis Fed — nearly double what they were a year earlier.
One way to avoid those high rates is to get a mortgage loan from your family instead of a bank or other commercial lender. Although family home loans traditionally have come in the form of helping cover down payments, more home buyers are turning to family members to cover mortgages as well, The Wall Street Journal reported.
These loans typically involve wealthy parents lending money to their adult children or wealthy grandparents doing the same for their adult grandkids, according to Timothy Burke, CEO of National Family Mortgage. In some cases, aunts and uncles are making mortgage loans to nieces and nephews, and siblings are making loans to each other. The advantage, of course, is that family members tend to offer much better terms and rates than commercial lenders.
If you’re looking into a family-backed mortgage loan — either through cash accounts or by tapping into an individual retirement account or other investment — you’ll need to familiarize yourself with the tax rules.
Family loans have a number of potential consequences involving estate, gift and income taxes, according to Fidelity. For the IRS to consider the transaction a loan rather than a gift, you’ll need to comply with a number of requirements.
For example, the IRS sets minimum interest rates for loans between family members to prevent people from disguising gifts as loans that charge minimal or no interest. The minimum rate is updated monthly and tied to bond yields, and it applies regardless of the borrower’s credit score. Borrowers might pay less in interest with a family loan than with a commercial loan, but they’ll have to pay some amount of interest rate for it to be considered a loan.
For July 2022, the minimum rates are as follows: 2.37% for loans under three years; 2.99% for terms of three to nine years; and 3.22% for terms of nine years and longer. For August the short-term rate is 2.88%, the mid-term rate is 3.15%, and the long-term rate is 3.35%, The Wall Street Journal reported.
Compared with current mortgage rates, the IRS minimum rate for family loans is a bargain. This is especially important for young people in their 20s and 30s who are tired of paying rent and ready to buy their first home but are also wary of getting locked into a 30-year mortgage with high rates.
“The value proposition is about wealth preservation and wealth transfer,” Burke told the WSJ. “It’s about keeping money in the family.”
Just make sure everything is put into writing — including a loan contract and a record of the mortgage that is properly vetted from both a legal and tax standpoint. Loans that are not documented can lead to tax problems and potential disagreements down the road.
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