Friday, October 15, 2010

Lending Money to Family for a House Purchase

A lot of families want to financially help a daughter, son, or grandchild with their first house purchase in beautiful Fraser Cheam* area British Columbia, Canada.  How to best go about helping them build equity in their "nest egg" is up to each family but I heard an interesting suggestion a week ago and thought that I would pass it on.

Building a Nest Egg © Stephen Mullock

This solution involved the family loaning monies, say $100,000 interest free (or could be at a low rate of interest) in the form of a registered on title second mortgage with the same term as the first mortgage.  In the event of the first mortgage being renegotiated the second was to come due and take on an interest rate of 8 percent.  This bump up to 8% does a couple of things, first, there is a disincentive by those borrowing the money to take additional equity out the property by increasing the first mortgage amount and secondly it may make them want pay off the second mortgage sooner particularly, assuming they can afford it, if first mortgage rates remain below the 8 percent stipulated in the second mortgage.

What sort of savings would such a situation offer a young couple?  With a 25 year amortization and a zero percent rate of interest they would pay back the second loan $333.33 a month.  At the end of 5 years they would have built $20,000 of equity into their property.  If they were to finance the $100,000 on a 5 year term, 25 year amortization at say 4% their payment would be $526.02 a month.  They would see a reduction in principal of $12,896 after 5 years and they would still owe $87,053.  In summary the benefits are a monthly reduction of close to $200 a month ($12,000 over 5 years) and over a five year period an equity gain of $7,000 not too bad.  Those loaning the money eventually get it back not foreseeing any disaster.

Now everyone's situation is different so it is important that strength of the loan is considered against the people involved, the employment background and the particular real estate investment being purchased.  A professional real estate agent should be able to give guidance in these matters.

If your family has a better solution I would like to hear about it, please send me a message.

* The Fraser Cheam area is found in the eastern section of the Fraser Valley about 100 Km from the Port of Vancouver and includes the communities of Agassiz/Kent, Chilliwack, Cultus Lake, Kent, Harrison Hot Springs, Harrison Mills, Hope, Rosedale, Popkum and Yarrow.

Stephen Mullock RI is an award winning full-time real estate agent with 29 years of experience and hundreds of sales. Thinking of buying or selling real estate in the Fraser Cheam communities of Chilliwack, Agassiz or Harrison Hot Springs? Contact Steve (click here) for experience, local knowledge, friendly service that is usually on time; you’ll be happy you did.

1 comment:

  1. Received this message from Brad Currie RI an experienced mortgage broker with Verico Versa Mortgages Corporation in the Fraser Valley.

    Hi Steve... enjoyed your article on helping family members buy a home.... I have been suggesting something similar to Clients for a number of years under what I call the "Family Equity Plan"

    Many families do not readily have $100,000 available but have significant equity in their home which is doing nothing. I recommend they use the equity and provide it to family to buy a home. I suggest ideas on repayment terms, interest free, making the payments or actually making a small profit on loaning the money. My experience is all families are different on how they view these types of situations. No one particular set up is best as it depends on the desires of each family.

    Registering the loan as a 2nd also protects the investment in the event of a relationship breakup. It does not become part of the young couples assets to be separated, only the true equity gain.

    In some situations I seen family in a cash position and earning minimal interest. They have set up a business arrangement whereby their son would pay a typical mortgage rate on the funds, which is a much better return than the parents would have just keeping their money in term deposits.

    Finally, another advantage I have seen in this plan, is avoiding CMHC premiums and policies. If enough funds (20%) can be provided, the young couple saves thousands in not borrowing their CMHC premiums and paying interest on them. Also, for more challenging files, avoiding CMHC is the only way the borrowers could even be approved.