It doesn't matter how low those interest rates go if you can't get qualified for a mortgage. Mitch Sandall discovered this the hard way when he tried to buy his first home.
Sandall and his wife Kelley were students at Utah State University in Logan last year when they found their dream home: Three bedrooms, two bathrooms, a two-car garage, 1,500 square feet upstairs and an unfinished basement all sitting on a third of an acre in Garland, Utah.
"We didn't want to pay rent if we could get into a house," Sandall said.
But then came reality. Both Sandall and his fiancé couldn't qualify for a mortgage.
Timothy Burke, the founder and CEO of National Family Mortgage in Norwood, Mass., sees this happen all the time.
"A lot of young people tend to find the house first and then there is like this rush to the finish line to actually buy their dream house," Burke said. "They get their heart set on a place, and after they go through the full qualification process they find that … they can't get a mortgage."
"Neither of us had a credit score," Sandall said. "We had just paid cash for everything all our lives."
They needed help.
In the current economy, more and more parents are stepping up to assist their children get into their dream home. The 2010 National Association of Realtors Profile of Home Buyers and Sellers found that 36 percent of first-time homebuyers needed help just to get a down payment. The profile found 27 percent received a gift from a friend or relative — usually their parents — and nine percent received a loan from a relative or friend.
Sandall's plans for after college were direct enough. He is majoring in agriculture business and will work on the family cattle ranch and farm when he graduates soon. At first he explored having his parents cosign. But then his parents had another suggestion. They would buy the house with cash and he could pay them back with monthly payments.
The economy is making similar plans more attractive across the country. The popularity of what are called intrafamily loans comes from a convergence of several factors, said Ron Clarke, the CEO of Century 21 Alliance in Philadelphia, Penn. Clarke described four trends:
1. Returns are low on many investments right now. If they help their children with a mortgage, the parents will make a higher return.
2. The price of a house has declined to a reasonable level. More parents can afford to help buy a $150,000 home than could when that home was $250,000.
3. More parents are concerned about their children's economic future as they hear about layoffs in many industries. They worry about what could happen if their children got into a long-term obligation where they might have to bail them out anyway.
4. Parents don't want children to be in a position where, if they put a little down and then the house declines in value, they will be upside-down in the mortgage.
"All of those things have combined, because there truly is a mutual benefit to both parent and child." Clarke said.
But there are risks as well, said Burke with National Family Mortgage. "We don't encourage parents to do this with every one of their kids. This is an opportunity for the right families with the right kids in the right situation."
Burke said the average person isn't aware of the complex tax laws surrounding both financial gifts and loans to family members. He said parents call his company and say things such as, "I paid off my kid's mortgage six months ago. I didn't know the annual gift limit was $13,000."
Individual gifts can be up to $13,000 or, in other words, two parents can give a total of $26,000 to a child. Loans need to be in writing. If a loan is more than $10,000 the IRS requires the lender to report interest income — even if they are not getting any interest payments from the borrower. The current IRS applicable federal rates for a long-term loan are 2.93 percent. The parent lender could, of course, set a higher rate and still charge less than a conventional bank loan.
Burke's company fills the unique niche of helping relatives with the documents and services needed for loaning to each other — things such as the creation of a promissory note (the main debt instrument) and the mortgage documents or your deed of trust (the security instrument).
The lending parents then have a public secured lien on the property and have all the rights of Bank of America. "I have yet to see a parent foreclose on their kid. But they have that ability," Burke said.
One advantage to carefully setting up a mortgage is the borrower can then legally deduct the interest. Another is the document sets clear expectations — sometimes for other family members. "If something happened to Mom and Dad, they want to make sure the loan is still paid. The parents don't want to potentially shortchange the other kids of their share of an inheritance if the borrower decides to not pay it back after the parents are gone," Burke said.
When Sandall's parents offered a mortgage to him, he was reluctant at first. "I was a little disappointed," he said. "I wanted to do it on my own. … But the idea grew on me."
Sandall's parents also had the advantage, since he would be working with them on the family ranch, of knowing exactly what his income potential was. Burke says this isn't completely unique, however.
"Who knows better than parents whether or not their son or daughter is responsible enough or in a position to pay a loan?" Burke said. "They have a lifetime of underwriting experience."
Low interest rates are also sending young homeowners to refinance — again only to find they can't qualify. Parents are stepping in again in these situations, Burke said. "They pay off the outstanding balance and replace it with a tax-deductable family mortgage."
The child gets the lower interest rate and the parents get a higher return than they would on other investments. "It is a win-win," Burke said.
But Sandall's parents were not looking at the intrafamily loan as a financial investment. They drew up their own loan documents and expected their son to transfer the debt to a conventional mortgage once he built his own credit history. It took about a year of credit cards and making payments on furniture, but Sandall transferred the loan to a bank just a few months ago.
"Instead of families moving in together, which would have been very much the trend in other places, more parents are trying to help their children live independent as opposed to having multifamily homes," Clarke with Century 21 said.
"In a tougher economy, families will find a way to help each other out."
And for Mitch and Kelley Sandall, it worked out well. They beat the banks and got into their dream home in Garland. "It's a nice house," said Sandall.