I learned that a colleague of mine bought a house with a loan from his parents. They agreed on a great rate for him (lower than existing bank loans) and a great interest rate for them (higher than anything they could get in a savings or CD). I though it was quite clever and reasonable for both sides. Am I missing something? (Besides the fact you have to have relatives with money willing to lend to you.)
FWbargains said: I learned that a colleague of mine bought a house with a loan from his parents. They agreed on a great rate for him (lower than existing bank loans) and a great interest rate for them (higher than anything they could get in a savings or CD). I though it was quite clever and reasonable for both sides. Am I missing something? (Besides the fact you have to have relatives with money willing to lend to you.)
Depends on the relatives. What you're missing is they are taking on additional risk for the marginally better rate. Housing could tank, colleague could lose job and default. Or, housing could tank and relationship sours and he walks on the house and they are forced to foreclose and take a large loss. Or housing costs stay stable but he loses his job and they won't kick him out (obviously) because they love him, and it's a potential drain on their finances (Unless they have much more $$$$ than the loan). Even without housing tanking, if it stayed completely flat then the sale of the house (in default) would only recover ~90% of the purchase price, assuming nothing was damaged and everything was well-maintained. Of course, they could be completely fine with this risk, depending on their relations with their son -- And it can be mutually beneficial and certainly help out a lot if they have no down payment saved up (of course, no down payment also adds to the parents' risk on the "investment" part of the deal, because it may indicate the son has no ability to save and have a cushion for emergencies.). My point is It's not actually a "great rate for them" on a risk-adjusted basis, though. The rest is all a great deal.
OP, there's really nothing "clever" about it. Everything is fine with such an arrangement until something goes wrong. All it takes is one little crisis, and everything ends badly. Would the parents foreclose on the kids when they miss a couple of payments? If the value of the home tanks, and the kids get a job transfer, will the kids screw the parents by just walking away from the house? So many things can go wrong.
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