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Using the family silver

It's hard to find lower loan rates than at the Bank of Mom & Dad. But beware the pitfalls.

January 01, 2006|Ann Perry | Special to The Times

SHAWN and Zuzana Landres were completing graduate degrees last year with the goal of working for nonprofit organizations when they did something that surprised even themselves.

They went home shopping.

Although most of their part-time income financed their educations -- his at UC Santa Barbara and hers at the University of Judaism -- the couple managed to snap up a three-bedroom, two-bath condominium in Westwood for more than $600,000. How'd they do that? Their mortgage was underwritten not by a financial institution but by family members.

Giving the younger generation a leg up in buying a home is a time-honored tradition for many families. According to a recent National Assn. of Realtors survey, 24% of first-time buyers receive a gift from a relative or friend to help with the down payment and another 6% receive a loan from a relative or friend.

Although recent low interest rates have enabled many first-time buyers to qualify for loans on their own with little or no money down, if interest rates continue to rise as anticipated and lenders tighten borrower requirements, the intergenerational loan could get a boost.

Financial experts caution, however, that not all parents should loan to their children. They could be putting their retirement income at risk.

If the loan is sealed with a handshake rather than written documents, there's a chance it might turn into a gift and create tensions among siblings. Loans improperly set up can cause borrowers who deduct interest payments to run afoul of the IRS. And should children default on an undocumented loan, parents may have little recourse to recover their money.

Still, those in the older generation who can afford to make a gift or a loan sometimes view it as a way of distributing some of their estate in advance so they can watch their children enjoy it.

"The point is, parents can give very-low-interest loans to their kids," said Asheesh Advani, president of CircleLending, the Waltham, Mass., company that formalized and administers the Landres' mortgage.

CircleLending, a pioneer in interpersonal loans, promotes "intra-family mortgages" as a low-cost way to keep wealth all in the family. The family loans can be used as a down payment, as a supplement to a down payment so the borrower can avoid paying private mortgage insurance, or to finance the entire mortgage at one to two percentage points lower than market interest rates, while providing parents with a stream of income competitive with conventional deposit rates.

For a basic fee of $549, the company documents and records the loan. It will also administer a payment schedule for $108 or $228 per year. CircleLending can help make sure the loan conforms to IRS rules if the borrowers want to deduct their interest payments on their income taxes, or if the older generation plans to forgive some or all of the interest or principal in the form of an annual gift to the borrowers.

The appeal of these intra-family mortgages is flexibility.

Consider the Landres' situation. The couple, in their early 30s, had saved toward a down payment. Shawn's mother, Renata Landres, approached her uncle, a 90-year-old, self-made businessman, for financing.

Meanwhile, Shawn found CircleLending online at www.circlelending.com and thought that formalizing the loan would appeal to the uncle's business sense. Ultimately, the family structured a 30-year, graduated-payment loan. The couple put down 20% -- mostly from their savings and some from their parents. Then the uncle loaned the 80% balance to the couple and to Shawn's parents' trust.

The unconventional, no-interest mortgage allowed the couple to beat out other bidders and close the deal quickly, said Shawn Landres. The couple pays no interest on the loan, with their payments instead reducing the principal.

Shawn Landres said that his great-uncle and great-aunt "were very supportive of the idea of us being owners, rather than renters. My uncle was the one who said, 'I'm not doing this to make money.' They wanted us to stay in L.A."

When Landres' great-uncle and great-aunt die, the loan balance will be due to their estate and the condo will have to be refinanced.

Renata Landres said she is comfortable helping guarantee the loan. "Shawn and I will make some other arrangement" when the time comes, she said.

Margarita Billings, chief executive of LandAmerica Southland Title Corp. in Burbank, said she's seen an increase in recent years in lending by parents to help grown children buy homes. Two years ago, she loaned her own son $20,000 from savings to help him make a 20% down payment on his first home in Seattle so he could avoid making PMI payments. The loan was recorded and her son has been good about making payments.

But as an escrow officer, Billings sometimes worries that family loans are too risky for the parents. She has seen older parents who own their property free and clear take out $100,000 equity loans to help children buy first homes. If the children default, the parents could lose their homes.

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