Strict underwriting standards and tighter credit conditions for mortgages are leading more borrowers to turn to friends and family for loans to help fund home purchases. But both borrowers and lenders both can run afoul of tax, legal and other complications if these personal loans aren’t structured properly.
Vendors have emerged to address this issue, developing services and Web-based technology to help individuals with much of the paperwork and process involved in creating these types of loans. The vendors facilitating these so-called peer-to-peer mortgages say their services also help traditional mortgage lenders avoid the risks associated with undisclosed borrower debt disguised as a down payment gift.
At the P2P vendor National Family Mortgage, 80% of the loans the company helps structure are between parents and a child. Typically, these loans help cover the cost of a down payment on a home purchase. Timothy Burke, the company’s CEO, told the audience at a recent real estate technology conference in New York City that many times parents will sign letters with mortgage lenders attesting that the down payment money is a gift, but behind the scenes, it’s really a loan that doesn’t get calculated in the borrowers’ debt-to-income ratio during underwriting.
“Technically, that’s mortgage fraud and I don’t understand why people want to do this when FHA guideline 5.C.5 lets your borrow your down payment,” Burke said, referring to a Department of Housing and Urban Development guideline that permits family members to lend borrowers the money for down payment, closing costs, prepaid expenses and discount points on Federal Housing Administration-backed mortgages, a popular loan product with first-time homebuyers.
With a P2P loan, the Norwood, Mass.-based company works with the family to set up the proper documentation to create a second mortgage. With this structure, borrowers can deduct interest expenses on their taxes, which is not allowed for personal, unsecured loans. The lenders benefit by earning a higher return on their money than a typical savings accounts or other products currently offer.
Once borrower and lender agree to loan terms, they fill out a Web form detailing the terms of the arrangement. National Home Mortgage creates the loan documents and emails them to the parties, who then sign, notarize and return them. The company handles the land recording and other closing tasks. Once the loan is in repayment, National Home Mortgage has a Web-based servicing platform for borrowers to submit payments to their family member lender.
National Home Mortgage said it has helped structured approximately $20 million in P2P mortgages, with an average interest rate of 3.7%. The smallest loan the company has helped structure was an $18,500 down payment; the largest was a $1.17 million refinance loan. It charges $599 to set up the loan and $15 per month for its optional Web-based servicing technology.
Another P2P lending vendor, LendFriend, offers similar services, but the borrower crafts a proposal that’s sent to prospective family and friend lenders, who can respond with counter proposals. Once the terms are finalized, LendFriend electronically transfers the money. The company also has servicing technology for loan repayment that it charges $0.50 and 1.5% of the payment per transaction.
San Francisco-based LendFriend said its loans are used for home purchase and other purposes. Speaking at the same conference session, CEO Geno Moscetti said including a third party in the process helps “compartmentalize” the emotions of lending among family members and helps expedite the “messy” issues like writing contracts and other documentation.
In their companies’ early business, the executives said delinquency and defaults are low on P2P loans, mainly because lender and borrower know each other well and wouldn’t have entered into the agreement if there were concerns about repayment. “Who has better underwriting experience than the Bank of Mom and Dad?” Burke asked. “It’s not for everyone, but there are certain situations where you can create a win-win.”
Moscetti said in cases of delinquency, loans can be delayed, not defaulted because the lender is typically more lenient and willing to work with borrowers than traditional banks. “The main concerns of the lender are ‘Am I going to help this person out’ and ‘Am I going to get paid back,’ not ‘Am I going to get repaid on this exact date 30 years from now,’” he said.
Neither company currently reports loan repayments to credit bureaus, but both Burke and Moscetti said it’s a function they are currently working to establish.
