Many Home Buyers Apply For Family Backed Mortgages As Interest Rate Hikes

It’s not the best time to buy a home, with home prices hovering near all-time highs and mortgage rates continuing to rise. 

The average mortgage rate on a 30-year loan was 5.54% on July 21, according to St. Louis Fed – almost double what they were a year ago.

One way to avoid high rates is to get a mortgage loan from your family instead of a bank or other commercial lender. 

Although single-family home loans traditionally come in the form of down payment assistance, many homebuyers are turning to family members to pay their mortgages as well, The Wall Street Journal reported.

According to Timothy Burke, CEO of National Family Mortgage, these loans often involve wealthy parents lending money to their grown children or wealthy grandparents doing the same for their grown grandchildren. 

In some cases, aunts and uncles lend to cousins, and relatives lend to each other. The advantage, of course, is that family members tend to offer better terms and rates than commercial lenders.

If you are looking for a loan to support your family – through cash accounts or by attaching it to an individual pension account or other investments – you need to familiarize yourself with the tax rules.

Family loans have many potential consequences, including estate, gift, and income taxes, according to Fidelity. In order for the IRS to treat the transaction as a loan rather than a gift, you must meet several requirements. 

For example, the IRS sets minimum interest rates for loans between family members to prevent people from disguising gifts as loans with little or no interest. 

The minimum rate is updated monthly and tied to bonds and applies regardless of the borrower’s credit score. Borrowers can pay a lower interest rate on a family loan than on a commercial loan, but they must pay a lower interest rate to qualify for a loan.

For July 2022, the minimum rates are as follows: 2.37% for loans up to three years; 2.99% for three to nine years; and 3.22% for nine years and longer. 

In August, the short-term rate was 2.88%, the intermediate 3.15%, and the long-term 3.35%, The Wall Street Journal reported. 

Compared to today’s 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 afraid of being locked into a 30-year, high-priced mortgage.

“The value proposition is about wealth preservation and wealth transfer,” Burke told the WSJ. “It’s about saving money for the family.”

Just make sure everything is in writing – including a loan agreement and credit report that is properly reviewed for legal and tax purposes. Loans without documents can lead to tax problems and potential misunderstandings.