Expert: Jay Denit - 9/26/2006

Question

I have a unique situation and I was hoping you could look this over. Let me know if you have any advice. Thanks.

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My best friend in CT needs $200K to buy a house. I am willing to give him the money if need be, but I'd rather find an arrangement where he gets a great deal, I make a little money, and the deal is 100% IRS legal.

A fixed 30-year mortgage at today's average rate of 6.44% yields a monthly payment of $1256 and he cannot afford that.

The house has an apartment unit on it, so one thing we have been considering is renting the apartment out to a 3rd party for about $800 a month and me paying him a management fee ... maybe $400 a month. This might be a longer term deal since he'd like to offer the apartment to one or both sons for the next five years at about $400 a month (they may or may not take him up on the offer).

I'm also wondering if it makes sense for us to have me own the mortgage or get a third party involved to own the mortage logistics, so to 'put some distance' between my best friend and me such that the deal looks beyond reproach from an IRS point of view.

And what if I bought the home and he rented it from me with a 'rent to buy' option. What are typical terms of such an agreement?

We are both 47 years old and single. He has two sons and I have no offspring. He would like any equity he gets in the house to be passed to his sons upon his death. I would want to forgive the debt if I was to die before him.

I put the above on a consumer help website and got this reply:

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Doing a private mortgage is not as complicated as you might think (I've used one myself) any real estate attny should be able to help you with that...though it won't be *required* you should do an appraisal on the property just like a bank would...make sure you are protected.

If you're objective is to provide as good of loan terms as you can, the good news is that you do NOT have to provide an Interest rate that is competitive with the overall Mortgage market, rather you only need to charge the minimum interest rate as specifed by the IRS...there are three different rates which depend on the *term* of the loan...short, intermediate, and long and are published every month...and these rates are much less than market rates for similar loans.
Perhaps someone else can point to this document as it is a bear to find on the IRS web site...and you should probably go over it with an accountant.

The other thing is you can make the terms of the loan almost anything you want...interest only for the first 5 years, then amortorized over 25 years...or heck IO for 30 years.

As far as your objective for the property to transfer to them when you die, that is something you should discuss with an estate attorney and I presume it could be handled easily by your will.

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Any advice? Any references you can suggest?  

Answer
Thanks for the question.  The consumer help website gave you good information.  There are several ways to attack the situation that you have.  We will leave the rental scenario to the side right now.  That would be a separate agreement to the mortgage and you can handle that any way you want as long as the income is reported.

The easiest is to do what's called a "hard money" loan to your friend.  It's the same thing as what the consumer website calls a private party mortgage.  

What that consists of, is you having the cash (200k)"hard money" and giving it to your friend and charging him a nominal interest rate (per IRS rates) on his payments to you.  It's not an atypical loan and happens more frequently than you might think.  You will want to have an attorney get involved to make sure everything is executed properly.  To protect you, don’t forget to have your mortgage recorded with the county, so you have a lien in place should something unforeseen happen to your friend.  You would need to protect your lien position as being a first lien. (An attorney can advise you of how to do that)

Another scenario to think about-- How close is your friend from being able to make the monthly payment on a standard 30 year loan product?  Something to consider is an Interest Only product.  That type of loan will only require him to pay interest, but affords him the ability to make additional principal payments each month.  

Something else to consider is, in negotiating the real estate sale that you have the seller pay a few discount points (1% of the loan amount is a point)to buy down your friends interest rate.  I would suggest finding a local mortgage company that you trust, to talk with your friend about different products to lower his payments.

All that said, if you want to be a party to the deal, I think a "hard money" loan would be the way to go, so that you make some money on the interest as well as helping your friend.  Having a business deal with your friend may be a good thing and it's a personal decision, but coming from a man with experience, think about what happens if your friend is unable to make payments.  It can get a bit sticky.

Definitley get an estate attorney involved with the transfer of property upon death.  Each state has different laws about that.

Thanks againf ro the question.  Please let me know if you need any more clarification.