I was talking with a friend that recently purchased his home with an ARM and did 100% financing. With little (or possibly negative equity with home prices dropping), he will certainly have a very difficult time refinancing into a fixed-rate when his rate begins to adjust. As it so happens, his mother-in-law recently inherited a large sum of money. More than likely he will end up borrowing from her and refinancing his mortgage with her. I told him I think it is a great idea, and it is basically peer-to-peer lending on a grand scale. Here are some of the many benefits of borrowing from a friend of family member:
- Very low closing costs
- Quick recovery of closing costs
- Low fixed rate
- Potentially higher cash flow for borrower
- Potentially higher cash flow for lender
Basically you will just have to pay the local and state government some fees (doc stamps, taxes, recording fees, etc.) for the documentation.
Because of the low closing costs, it won’t take very long at all to recover your closing costs. It will likely take on the order of a few months as opposed to years with a traditional refinance.
Your friend and relative may even be kind enough to loan to you at 0%, but a fair rate would be something between that of a standard 30-year fixed loan with an institution (assuming that is the term you use) and the interest rate of a high-balance money market account.
Depending on your current financing situation, because of the lower rate, the refinance may leave more money in your pocket each month.
If the interest rate is higher than that of a high-balance money market account, the lender will enjoy better cash flow as well. Technically speaking, the amortization of the loan will also provide increased cash flow. However, it isn’t additional income since it is additional cash going towards the balance and the balance of the loan (investment) is declining.
Of course, when there are benefits there are also disadvantages as well. In this case, it is the potential ill-will if you were to ever default on the loan or make late payments. So I will offer the following disclaimer: if you are late with payments or default on your loan, a family member may disown or oust you from the family, a friend may never forgive you and will no longer be your friend, and in either case you may be sued and your home may be foreclosed. In other words, I’m well aware that what I’m suggesting in this article probably goes against everything you’ve probably ever heard about borrowing/lending money to friends and family. Now you are aware of it as well.
That being said, there is one major disadvantage for the lender. Even if you do everything by the book and set up a note and everything, if the lender ever wants to sell the note it would likely have to be at a significant discount of face value (because of the low interest rate). So the lender is more or less locked into the investment until the note matures or the home is sold. All-in-all I think it is a fairly good deal for the borrower and lender as long as both parties understand the terms, conditions, and risks.